Download Volume 73 No. 4, December 2010 Contents

Volume 73 No. 4, December 2010
Contents
Editor’s note
3
Articles
Regulating non-bank deposit takers
Felicity Barker and Noemi Javier
5
Bringing financial stability legislation to the insurance industry - the Insurance (Prudential Supervision) Act 2010 19
Richard Dean
Global currency trends through the financial crisis
Zoe Wallis
28
New Zealand’s imbalances in a cross-country context
Daan Steenkamp
37
For the record
Discussion papers
News releases
Publications
Articles in recent issues of the Reserve Bank of New Zealand Bulletin
50
52
59
60
This document is also available at www.rbnz.govt.nz
Copyright © 2010 Reserve Bank of New Zealand
ISSN 1174-7943 (print)
ISSN 1177-8644 (online)
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
1
www.rbnzmuseum.govt.nz
The Reserve Bank Museum
celebrates and records New
Zealand’s economic and banking
heritage.
•
See the MONIAC hydraulic computer.
•
Understand how the economy fits
together.
•
Explore part of the Reserve Bank’s
unique currency collection.
•
Visit our interactive displays online
at www.rbnzmuseum.govt.nz – then
complement your experience by
exploring other exhibits in the real
thing.
Open 9.30am–4.00pm weekdays. The
museum is closed weekends, public
holidays, and for special events. Please call
to confirm opening hours.
Reserve Bank Museum
2 The Terrace
Wellington
New Zealand
ph 04-471-3682
email: [email protected]
www.rbnzmuseum.govt.nz
Photography by Stephen A’Court.
2
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
Editor’s note
IIn the December edition of the Reserve Bank Bulletin for
availability and cost of external financing. The article notes
2010, we present a number of articles that span a range of
that debt maturity has lengthened recently in response to
the Reserve Bank’s functions.
both market pressure and the Reserve Bank’s Prudential
The first article by Felicity Barker and Noemi Javier explains
new regulations for non-bank deposit taking institutions
(NBDTs) that apply from 1 December 2010. The NBDT
sector consists of building societies, credit unions and
finance companies. The new regulations form an additional
Liquidity Policy. High debt levels threaten to weigh on
economic growth by raising the cost of capital and crowding
out private investment. The article also argues that faster
fiscal consolidation would help rebalance the economy
towards exports and towards higher savings.
component in the Reserve Bank’s prudential regulation
I hope you find this edition to be informative and enjoy the
regime aimed at promoting the soundness and efficiency in
Christmas break.
the financial system.
The second article by Richard Dean details the Insurance
Kirdan Lees
(Prudential Supervision) Act 2010. This Act brings financial
Editor
stability legislation to the insurance industry. The article notes
that failure of an insurer can have significant impacts on
large numbers of policyholders of all descriptions and argues
for appropriate prudential regulation. The article then steps
through the detail of the Act, exploring the rationale for the
new legislation, the objectives of the Act and the Reserve
Bank’s approach to achieving these objectives.
The third article by Zoe Wallis discusses trends in currency
trading across the global financial crisis. The article makes
particular use of the most recent BIS triennial survey of
currency trading. The survey shows that daily foreign
exchange turnover has continued to increase, albeit at
a slower rate than over the past three years. Moreover,
the popularity of the ‘carry trade’ has decreased because
of increased volatility in currencies generally and the New
Zealand dollar has become less of a focus for international
traders. It remains to be seen whether markets gradually
return to an environment of lower volatility and increased
risk appetite or whether the popularity of the New Zealand
dollar will return to pre-crisis levels.
In our final article, Daan Steenkamp considers New Zealand’s
imbalances in a cross-country context, highlighting sources
of vulnerability. The article begins with the build up of New
Zealand’s large and negative net international investment
position that has been financed through foreign debt
typically of short maturity. This reliance on short-term foreign
financing makes New Zealand vulnerable to changes in the
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
3
4
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
ARTICLES
Regulating non-bank deposit takers
Felicity Barker and Noemi Javier
The non-bank deposit taking (NBDT) sector comprises building societies, credit unions and finance companies. NBDTs
can play an important role in the economy, providing services complementary to those provided by banks. In recent
years, many finance companies have failed, resulting in a significant loss of value in the sector. These failures have
revealed weaknesses in the operating models of several finance companies, such as high levels of related party exposures
and inadequate capitalisation relative to the risks taken.
On 1 December 2010, NBDTs became subject to new regulatory requirements relating to capital adequacy, related party
exposures, liquidity and governance. This represents a further step in the implementation of a new prudential regulatory
regime administered by the Reserve Bank. Regulations setting out credit rating requirements came into force on 1 March
2010 and NBDTs have been required to have a risk management programme since September 2009.
The new regulatory regime is aimed at promoting the soundness and efficiency of the financial system by setting
minimum prudential standards that NBDTs must meet. The requirements have been modelled on the banking regime,
but have been tailored so that they are fit for purpose for the NBDT sector.
This article explains the requirements in force on 1 December 2010 and discusses the motivation for these
requirements.
Introduction
Bank Act (the Act) in September 2008.1 The Reserve Bank’s
1
powers in the NBDT sector are expected to be expanded next
The Role of the Reserve Bank
On 1 December 2010, NBDTs became subject to new
regulatory requirements relating to capital adequacy,
related party exposures, liquidity and governance.
These
requirements represent a major step in the implementation of
a new prudential regulatory regime for NBDTs administered
year. The Reserve Bank is consulting on a second Bill that
would grant it powers in relation to licensing, fit and proper
person requirements, changes of ownership and powers of
intervention, such as the power to obtain information or
give directions in certain circumstances.
by the Reserve Bank. Other existing requirements under the
The new prudential powers complement the Reserve
prudential regime are the requirement for NBDTs to have a
Bank’s existing powers as the regulator and supervisor of
credit rating and the requirement for NBDTs to have a risk
the banking sector. In addition, in September 2010, the
management programme. These requirements came into
Insurance (Prudential Supervision) Bill was passed making
force in March 2010 and September 2009 respectively.
the Reserve Bank the prudential regulator and supervisor of
The Reserve Bank’s new regulatory powers over NBDTs
derive from the addition of a new Part 5D in the Reserve
On 1 December 2010, NBDTs became
subject to new regulatory requirements
the insurance sector. These changes have created a single
prudential regulatory agency for financial institutions in New
Zealand and bring a common purpose to the regulation
of these entities; namely, the promotion of a sound and
efficient financial system. However, in the case of the NBDT
sector, trustees act as the supervisors, unlike for banks
relating to capital adequacy, related
and insurance companies where the Reserve Bank is both
party exposures, liquidity and
regulator and supervisor (see box 1).
governance.
1
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
See http://www.rbnz.govt.nz/about/ourlegislation/
index.html to access the legislation.
5
Figure 1
Institutional structure of the New Zealand financial sector
Financial
institutions
Registered
banks
($373bn)
Non-Bank
lending
institutions
($23bn)
Insurance
companies
($16bn)
Locally
incorporated
($327bn)
Branches
($46bn)
Deposit-taking
finance
companies
($9.4bn)
Regulated and supervised by the
Reserve Bank
Other
financial
institutions
($60bn)
Non-bank deposit
takers
($13.2bn)
Non-deposit-taking
finance
companies
($9.7bn)
Building
societies and the
PSIS
($3bn)
Credit unions
($0.8bn)
Regulated by the Reserve Bank
Not regulated or supervised by the
Reserve Bank
Note: Source RBNZ. Numbers in brackets refer to the total assets of the sector. Bank and non-bank lending institution
data as at 30 June 2010 and insurance data as at 31 December 2008. The number for deposit-taking finance companies
includes firms in receivership, moratorium or liquidation. UDC is included in the figure for registered banks and not
in the deposit-taking finance company sector.
In recommending regulations for the NBDT sector, the
2
Reserve Bank has used the banking regime as a point of
reference.
However, the Reserve Bank has also been
conscious to ensure that regulatory costs are not unduly
onerous for small entities and that regulation appropriately
recognises that NBDTs operate under different business
models to banks. Hence, requirements have been tailored
to be fit for purpose for the NBDT sector.
The NBDT sector and the
rationale for regulation
The NBDT sector comprises two main types of entity: deposittaking finance companies and savings and lending institutions
such as building societies, credit unions and the PSIS Ltd (a
co-operative company). The essential characteristic for an
institution to be subject to the NBDT prudential regime is
that it offers debt securities to the public and then lends the
The new prudential powers complement
money out or otherwise provides financial services.2
the Reserve Bank’s existing powers as the
The NBDT sector represents less than 5 percent of the
regulator and supervisor of the banking
financial assets held by financial institutions in New Zealand.
sector. In addition, in September 2010
the Insurance (Prudential Supervision) Bill
was passed making the Reserve Bank the
prudential regulator and supervisor of the
insurance sector.
6
2
Section 157 of the Act defines a deposit taker as “a
person who offers debt securities to the public in New
Zealand and carries on the business of borrowing and
lending money, or providing financial services, or
both.” Banks, collective investment schemes, local
authorities and the Crown are specifically excluded.
In this paper, we use the term NBDT to mean deposit
taker as defined by the Act.
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
The failure of many finance companies
development sector will remain reduced as the model
over recent years has highlighted a
of retail funding for high risk exposures has been proven
number of areas where regulation and
unsustainable.
supervision of the NBDT sector has
In comparison, savings institutions have generally operated
been inadequate.
under more conservative business models than finance
companies. Savings institutions have performed relatively
Other financial institutions include registered banks,
well over the recent period and have not suffered similar
insurance companies, non-deposit-taking lending institutions
failures.
and other financial institutions, such as superannuation and
managed funds (figure 1). Although NBDTs only comprise a
small proportion of the financial system, the sector can play
an important role in the economy, often financing activities
with which banks have not traditionally been involved.
taken in the NBDT sector, particularly by finance companies,
for a number of years.3
The failure of many finance
companies has highlighted a number of areas where the
regulation and supervision of the NBDT sector has been
Since 2006 a number of finance companies have filed
for receivership or liquidation, gone into moratorium or
otherwise exited the market. This has seen a significant
reduction in the assets held by finance companies and a
significant reduction in lending from the NBDT sector. In
2006, deposit-taking finance companies accounted for
approximately $12 billion in assets.
The Reserve Bank has had concerns about the level of risk
The Reserve Bank
estimates that the remaining active deposit-taking finance
companies (that is finance companies not in moratorium,
receivership or liquidation) now account for approximately
$5 billion in assets. Finance companies engaged in property
inadequate.
In particular, many finance companies held low levels of
capital for the level of risk they took and lacked diversification
in their loan portfolios. This left them vulnerable to adverse
changes in economic conditions.
Further, many finance
companies had high levels of related party exposures in their
loan books. In addition, the absence of uniform measurement
standards and limited transparency in financial information
made it difficult for the market to assess and compare risks
across the sector. These issues have contributed to declining
confidence and consequent funding and liquidity problems.
development lending have had a particularly high rate of
failure and lending to this sector has been greatly reduced.
It is likely that the NBDT sector’s exposure to the property
In October 2008, the government implemented the Crown’s
Retail Deposit Guarantee Scheme, which covered qualifying
NBDTs.
The original scheme expired in October 2010.
Figure 2
An extended version of the scheme, with more stringent
Assets of active deposit-taking finance
qualification requirements, is in operation until December
2011. Only a small number of entities are participating in
companies in 2006 and 2010
$bn
$bn
12.5
this scheme.
12.5
10.0
UDC
SCF
Hanover
Marac
BridgeCorp
Strategic
Other
7.5
The following sections of this paper discuss the requirements
10.0
for NBDTs in force as at 1 December 2010.
7.5
5.0
5.0
2.5
2.5
3
0.0
0.0
2006
Source:RBNZ
Note: Excludes finance companies operating under a
moratorium arrangement or that are in receivership.
The chart identifies specific finance companies with
assets over $500 million only.
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
See for example the 2004 Financial Stability Report p21
which commented, in relation to the rapid growth of
non-bank financial institutions, that “if the economy
slows next year, as is projected, that could provide a
litmus test of the extent to which the growth recorded
by this sector reflects sustainable expansion in its
role...and the extent to which growth has been
achieved by taking on additional risk”.
7
Box 1
trust deed does not comply with prudential requirements
Trustees’ powers and duties
and the trustee is unable to agree to a change with the
In the case of banks and insurance companies, the Reserve
Bank is both regulator and supervisor. But for NBDTs, the
Bank is the prudential regulator, while trustees act as frontline supervisors. This arrangement is unique to the NBDT
NBDT. Trustees are required to report certain matters to
the Reserve Bank, such as if an NBDT is not complying with
regulations or if an NBDT is unable to pay debts as they
become due.
In order to enhance cooperation between trustees as
sector.
NBDTs are required, under The Securities Act 1978, to
appoint a trustee to represent the interests of security
holders. In this capacity, trustees supervise and monitor
the performance of NBDTs and take actions in the event
of breaches of trust deeds. Minimum prudential standards,
set by way of regulations made under the Act, are imposed
on NBDTs through trust deeds executed between the NBDT
and the trustee. Trustees may negotiate for more stringent
front-line supervisors and the Reserve Bank as prudential
regulator, the Reserve Bank entered into a Memorandum
of Understanding (MOU) with the Trustees Corporations
Association of New Zealand (TCA) and its members and
associate members. The focus of the MOU is to facilitate
an ongoing working relationship between trustees and the
Bank, with the intent to promote open communication
and active exchange of information.
prudential requirements if they consider it justified for a
For its part, the Reserve Bank endeavours to provide
particular institution and in the best interest of security
guidance and assistance to TCA and its members in
holders.
implementing regulations made under Part 5D. The MOU
In line with the regulatory framework for NBDTs, the
Act has given trustees additional powers and duties. For
example, a trustee can amend a trust deed where said
will be reviewed on a regular basis to ensure that it remains
relevant and effective in promoting cooperation and
coordination among the parties concerned.
Prudential Requirements
The first new requirement under the
3
NBDT prudential regime came into
Risk-management programme
Many of the finance companies that failed over recent years
force in September 2009. This required
had poor risk management practices. For example, some
that NBDTs have... a risk management
finance companies had poorly diversified loan portfolios,
programme.
or loans held with inadequate security, e.g. subordinated
mortgages coupled with schemes which allowed interest to
be added to principal rather than being paid.
The Reserve Bank has issued guidelines to help NBDTs
comply with the requirement to have a risk management
The first new requirement under the NBDT prudential
programme. Some of the matters covered by the guidelines
regime came into force in September 2009. This required
are:
that NBDTs have, and take steps to comply with, a risk
management programme setting out procedures for the
• the programme should cover all activities affecting the
NBDT’s risk profile and cover all material risks;
identification and management of credit, liquidity, market
• where possible, the NBDT should quantify its exposure
and operational risk.4
to risk;
4
8
Section 157M of the Act requires that every deposit
taker must have a risk management programme
and take all practicable steps to comply with that
programme.
• contingency plans for managing stress events should be
included; and
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
• the programme should be regularly reviewed.
Guidance is also provided on best practices to be followed
for operational considerations, such as the role of the
governing body and senior management, and definitions for
credit, liquidity, market and operational risks are given.
4
Credit ratings
Credit ratings assist investors in making investment decisions
by providing a simple way to compare the financial strength
of different institutions.
A poor credit rating indicates
that there is a higher risk that an institution will default
on payments to investors. For example, a triple A-rated
institution’s probability of default is approximately 1 in
600 over 5 years, whereas a double B-rated institution’s
probability of default is approximately 1 in 10 over 5 years.5
As of 1 March 2010, NBDTs have been required to have
a credit rating from an approved rating agency, unless an
exemption applies.6
NBDTs for which the consolidated
liabilities of the borrowing group are less than $20 million
are exempted from this provision until 1 March 2013.7 The
$20 million threshold was set in recognition that the cost of
obligations payable in New Zealand.
For NBDTs an issuer
rating was preferred as it provides a benchmark rating of
NBDTs (which is not dependent on the priority of a particular
issue of securities) and is also likely to be relatively easy for
depositors to understand.
5
Capital requirements
Minimum capital requirements are a basic prudential
requirement for banks and NBDTs.
An entity’s capital
comprises shareholders’ equity and accumulated earnings; it
represents the owner’s funds at risk. Hence, capital provides
an incentive for owners to manage the business prudently
and provides a cushion to protect depositors and other
creditors against unexpected losses.
Many finance companies have been inadequately capitalised
relative to the risks taken. This made them vulnerable to
possible failure in the face of adverse economic conditions.
The following table shows an estimate of the capital ratio
for four failed finance companies, measured using the NBDT
capital adequacy framework discussed below, compared to
their reported equity-to-assets ratio prior to their failure.
obtaining a credit rating would be disproportionately high
Regulations stipulating a minimum capital ratio to be
for small institutions.
included in the trust deeds of NBDTs came into force on 1
Ratings may apply to a particular issue of securities or to the
December 2010.9 The regulations require that NBDTs with
issuer itself. An issuer rating evaluates the creditworthiness
Table 1
of an entity, whereas an issue rating rates a particular issue
Comparison of capital ratios for failed NBDTs
of securities (which depends on where the debt ranks in
NBDT
Capital
ratio NBDT
framework %
(estimate)
Equity/assets
last accounts %
banks are required to maintain an issue rating, applicable
Bridgecorp
2-4
8
to their long-term senior unsecured New Zealand dollar
Dorchester
2 1/2- 4
11
Hanover
1-3
11
South Canterbury
Finance
-5.7
9.5
order of preference in insolvency). Regulations require that
NBDTs hold a long-term issuer rating.8 In contrast registered
5
6
7
8
The probability of default refers to the approximate
median likelihood that an investor will not receive
repayment on a five-year investment on time and in
full, based upon historical default rates published
by rating agencies. See http://www.rbnz.govt.nz/
finstab/nbdt/requirements/3857981.html for more
information on credit ratings and a list of NBDTs
that have received credit ratings.
Section 157I of the Act requires that deposit takers
have a credit rating provided by an approved rating
agency.
Deposit Takers (Credit Ratings Minimum Threshold)
Exemption Notice 2009.
Deposit Takers (Credit Ratings, Capital Ratios, and
Related Party Exposures) Regulations 2010.
Source:Figures for Bridgecorp, Dorchester and Hanover
are an RBNZ estimate made in 2008 based on data
available at the time. These figures may overstate
the true capital position of the entities. Data for SCF
is as at 31 December 2009.
9
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
Deposit Takers (Credit Ratings, Capital Ratios and
Related Party Exposures) Regulations 2010. Capital
ratio regulations are promulgated under Section
157S of the Act. Section 157P allows for the setting
of a minimum capital level. This is not a requirement
at present.
9
Figure 3
Calculation of the capital ratio
Gross capital
Risk-weighted credit exposures
Less
Plus
Deductions
Operational and market risk exposures
Gives
Gives
Capital
Total risk-weighted exposures
Actual capital ratio
(Capital/total risk-weighted exposures) x 100
Minimum ratio = 8%
10% if NBDT does not have a credit rating
a credit rating hold a minimum of 8 percent of capital to
adjustments were made where necessary to take account of
total risk-weighted exposures and an NBDT without a credit
different characteristics in the NBDT sector compared to the
rating hold a minimum of 10 percent. Trustees may require
banking sector.
that a higher capital ratio be set in the trust deed, should
they judge the position of the NBDT to warrant additional
capital.
The essential elements of the capital adequacy framework
are the calculation of:
This requirement is similar to banks, which are
required to hold a minimum of 8% total capital to total riskweighted exposures.
•
capital; and
•
total risk-weighted exposures.
The framework defines what types of capital instruments can
be included in gross capital. Capital is then calculated as the
Capital adequacy framework
The NBDT capital adequacy framework determines how to
difference between gross capital and required deductions.
compute an NBDT’s capital ratio. It is largely based on the
We use the term ‘total risk-weighted’ exposures to refer
banking regime’s capital adequacy framework, which itself
to the sum of the risk-weighted amount for credit risk and
is based on “Basel II” requirements.10 For the NBDT sector,
the aggregate amount for market risk and operational
risk. Credit risk is the risk of loss to an NBDT arising from
Many finance companies have been
a counterparty defaulting on or being unable to meet its
inadequately capitalised relative to the
obligations. This is the main component of risk exposures.
risks taken. This made them vulnerable
Market risk measures the level of risk an NBDT faces from
to possible failure in the face of adverse
changes in interest rates, exchange rates and equity prices.
economic conditions.
Operational risk refers to risks arising from the running of
the business, such as fraud and legal risk.
10
10
The Basel Committee on banking supervision provides
a forum for regular cooperation on supervisory
matters. From time to time, the Committee issues
non-binding guidelines and supervisory standards to
inform national banking regulators.
The capital ratio is calculated as the percentage of the
NBDT’s capital to total risk-weighted exposures.
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
If the NBDT is part of a borrowing group (comprising the
A number of deductions are then made from gross capital
deposit taker and all its guaranteeing subsidiaries), the capital
to arrive at the measure of capital used for the purposes
ratio must be calculated on a consolidated basis. Below, we
of calculating the capital ratio. These deductions include
provide more detail on the calculation of the capital ratio.
items such as goodwill, intangible assets and deferred tax
benefits.12 The deductions ensure that what is counted as
capital is truly available to absorb unanticipated losses in the
Capital
event of financial distress.
The banking regime allows two types of capital for regulatory
purposes: tier 1 and tier 2.
Tier 1 capital represents a
permanent and unrestricted commitment of funds with the
Total risk exposures
ability to absorb losses without the need for the entity to
NBDTs are required to hold capital against credit, market and
cease trading. Tier 2 capital has some of the attributes of tier
operational risk.
1 capital but is restricted in its ability to absorb losses other
than in a winding up. Tier 2 capital may, for example, have a
stated maturity date that limits the life of the instrument.
Credit risk
As with banks, the amount of capital an NBDT is required
In addition to being required to hold a minimum ratio of
to hold against credit risk depends on the riskiness of the
total capital to total risk-weighted exposures of 8 percent,
NBDT’s assets. To make capital requirements risk sensitive,
banks are required to hold a minimum ratio of 4 percent of
credit risk is calculated by multiplying the value of assets in
risk-weighted tier 1 capital to total risk exposures.
defined assets classes by risk weights. Risk-weighted assets
For the NBDT sector, only tier 1 capital is permitted for
are them summed up to calculate ‘risk-weighted credit
capital adequacy purposes. The main reasons for this are:
exposures’.
very few NBDTs have tier 2 capital instruments; tier 1 capital
The NBDT capital adequacy framework recognises a number
is available to absorb losses without requiring the entity to
of asset classes including: cash; claims on the Crown or
cease trading; a single-tier regime is simpler to understand
Reserve Bank; claims on other New Zealand-registered
and administer than a multi-tier regime; and, significantly,
banks; residential mortgages; property development loans;
the international regulatory community is moving towards
loans secured over machinery; personal loans and equity
greater emphasis on tier 1 capital in the banking regime.
investments. Several of these categories are further divided
Under the NBDT regime, gross capital consists of:
into sub-classes based on certain risk characteristics. For
• issued and fully paid-up ordinary shares;
• fully paid-up perpetual non-cumulative preference
shares;11
example, mortgages are further categorised in terms of the
ranking of the security and the loan-to-value ratio (LVR).
The risk weight applying to a particular asset indicates the
degree of risk associated with that asset. For example, cash
• retained earnings and reserves; and
carries a risk weight of 0 percent; first ranking residential
• minority interests.
mortgages with an LVR of between 80-90 percent carry a
risk weight of 100 percent; second or subsequent ranking
property development loans carry a risk weight of 300
11
Non-cumulative preference shares can only be
included in capital if they meet certain criteria
prescribed in clause l0(4) of the regulations, such as
that the payments of dividends must be able to be
withheld and the shares are not redeemable at the
option of the holder. Further, under clause 10(5)
non-cumulative preference shares without full voting
rights may not be more than 25 percent of capital if
the NBDT is not a qualifying mutual, and 50 percent
of capital, if it is a qualifying mutual.
percent.13
12
13
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
Clause 10(3) of the Deposit Takers (Credit Ratings,
Capital Ratios, and Related Party Exposures)
Regulations 2010 sets out the full list of deductions
that must be made.
The risk-weights are included in the Schedule to the
Deposit Takers (Credit Ratios, Credit Rating and
Related Party Exposures) Regulations 2010.
11
Box 2
The risk weights for NBDT residential housing loans used
Calculating risk weights for
the housing risk weights from the bank standardised
approach as the starting point. These risk weights were
residential housing
then amended to reflect the characteristics of the NBDT
The approach to the calculation of risks weights for
the NBDT capital adequacy framework is based on the
approach used for banks. For banks, however, risk weights
are derived from the Basel II standardised model, or
alternatively from the internal models approach, provided
that the bank meets certain criteria and has secured the
Reserve Bank’s approval. Under the standardised model,
risk weights for asset categories are prescribed. Under the
internal models approach, banks may use their own models
to generate input for calculating risk weights, subject to
the approval of their models by the Reserve Bank.
sector by drawing on outputs generated by the Reserve
Bank’s housing lending risk model. This model simulates
various scenarios and computes, in each of these scenarios,
factors such as probabilities of losses and defaults for a
mortgage portfolio. The inputs used to calibrate the NBDT
framework were the same as for banks, with the exception
of volatility in housing prices, which was increased to
reflect that NBDTs are typically more exposed to regional
housing lending portfolios and are hence more vulnerable
to regional house price volatilities. These differences, and
the updating of inputs used in the Bank’s model, led to
Although a similar approach to calculation of risk weights
higher risk weights in the NBDT framework compared with
as in the standardised approach for banks was applied
the standardised banking framework for mortgages with
in the NBDT framework, the resulting risk-weights are
an LVR of over 80 percent. The higher risk-weight also
different for a number of asset classes. This is because the
reflects that there are some circumstances where banks are
calculation of risk weights takes account of a number of
required to hold capital for housing loans where NBDTs are
differences between banks and NBDTs, such as the higher
not (e.g.housing loans in default).
level of risk in NBDTs’ portfolios due to a lower level of
diversification. The NBDT risk weights were also calculated
using more up-to-date data.
Banks also calculate risk-weighted credit exposures by
summing up risk-weighted assets.
Where differences
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between the NBDT and banking sector are unimportant, the
An average of total assets and risk-weighted credit
risk weights for NBDTs are the same as for banks (e.g., cash
exposures is used, as both these measures are likely to be
carries a weight of 0 percent in both regimes). However
correlated with particular measures of market or operational
for a number of classes of exposures, different risk weights
risk. The scalar is derived from registered banks’ operational
have been prescribed for NBDTs to better reflect particular
and market risk figures but adjusted upward to reflect the
characteristics in this sector. The calculation of risk weights
fact that operational risk is generally higher for smaller
is discussed in more detail in box 2 with regard to an example
institutions.
of calculating the risk weights for residential housing.
In the banking regime, operational risk capital is either
calculated as a scalar of a moving average of both balance
Market and operational risk
sheet and income statement items, or may be based on a
The amount of capital required to cover market and
bank’s internal model where Reserve Bank approval has
operational risks for NBDTs is calculated by multiplying the
been obtained. Market risk capital is calculated using the
average of the book value of total assets and risk-weighted
market risk exposures methodology. These methodologies
credit exposures by a scalar, is:
are complex and were not considered appropriate for the
NBDT sector.
12
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
6
Related party exposures
Registered banks are also subject to limitations on related
Related party exposures can be problematic because
party exposures. Similar to NBDTs, credit exposures to a
relationships with related parties can be abused.
non-bank connected person are not to exceed 15 percent
For
example, related parties may be accorded preferential
of the banking group’s tier 1 capital.
treatment or may not be subject to as rigorous credit checks
credit exposures (non-bank and bank connected entities),
as would be the case for non-related parties.
banks are subject to a ratings-contingent framework that
A number of finance companies that
failed over recent years had high levels of
related party exposures.
For aggregate
correlates the maximum level of connected exposures to the
bank’s credit rating.15 For example a bank with a double A
or above credit rating can have exposures of 75 percent of
tier 1 capital, a bank with an A rating can have exposures of
40 percent of tier 1 capital.
A number of the finance companies that failed over
recent years had high levels of related party exposures.
For example, some finance companies extended loans to
companies or projects promoted by a director of a company
in the same borrowing group as the finance company. In
other cases, loans were extended to a related party of the
finance company’s parent entity and may even have been
guaranteed by the parent. Analysis of related party exposures
was difficult due to the absence of uniform standards and
The Act defines a related party, in relation to a NBDT. This
definition has been extended by regulation.16 The definition
covers key office holders, those with a substantial interest
in the entity and other entities with significant ownership
or directorship crossover. The definition is similar to that
applying to banks; the main difference is the inclusion
of interlocking directorships and a lower threshold for
substantial interest for NBDTs.17
definitions to measure related party exposures. Figure 4
shows the percentage of related party exposure to paid
up capital for building societies, credit unions and finance
companies.
7
Liquidity
Liquidity risk refers to the risk that either: (a) an entity cannot
meet its financial obligations as they fall due; or (b) an entity
Regulations on related party exposures came into force on 1
can only meet its financial obligations at an elevated cost.
December 2010.14 The regulations provide for a maximum
The policy rationale for liquidity requirements is two-fold.
limit on aggregate related party exposures of no more than
First, an entity that cannot raise funds to meet its financial
15% of the capital of the NBDT, or if it is part of a borrowing
obligations at reasonable cost may become insolvent. This
group, relative to the capital of that borrowing group.
could result in a loss of confidence in the sector and lead to
a further withdrawal of funding for the remaining entities.
Figure 4
Related party loans to paid up capital (%)
%
30
on entities’ liquidity management so that they can make
quality investment decisions.
31/12/2008
25
Second, it is important that investors have good information
31/01/2009
28/02/2009
20
31/03/2009
15
14
15
16
17
30/04/2009
10
5
Building societies
Credit unions
Finance companies
Source RBNZ 2009
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
Deposit Takers (Credit Ratings, Capital Ratios,
and Related Party Exposures) Regulations 2010.
Related party regulations are promulgated under
section 157V of the Act.
The policy for banks is contained in BS8 “Connected
Exposures” in the Banking Supervision Handbook:
h t t p : / / w w w. r b n z . g o v t . n z / f i n s t a b / b a n k i n g /
regulation/0094291.html
Section 157B of the Act and Clause 4 of the Deposit
Takers (Credit Ratings, Capital Ratios, and Related
Party Exposures) Regulations 2010.
See the annex for more detail on the definition of
‘related party’.
13
Within the NBDT sector, liquidity management practices are
Regulations that came into force on 1 December 2010
varied. Credit unions and building societies provide bank
require that trustees and NBDTs agree appropriate
like transaction services to their clients and are hence funded
quantitative liquidity requirements to be included in trust
mainly from on-call funds or funds at short-term maturities.
deeds.18 In practice, this allows requirements to be tailored
These institutions generally hold high levels of liquid assets
to the business model of the NBDT; provides the trustee
to manage the risk of excessive withdrawal of funds.
with powers to monitor and enforce those requirements;
Finance companies have been used as longer-term savings
and provides investors with information to assess different
vehicles for depositors and hence tend to have a greater
NBDTs. Many, but not all, trust deeds already contain some
proportion of funding at maturities of greater than one year.
form of liquidity requirements. The Reserve Bank has also
Their liquidity management strategy is to try and match the
issued non-binding guidelines to assist the sector to develop
maturities of funding to that of lending. It is important that
appropriate requirements and therefore fulfill the obligations
any requirements relating to liquidity are sufficiently flexible
in the regulations. These guidelines set out matters such as
to allow NBDTs to manage liquidity in a way appropriate to
the measurement of liquidity risk, assets that may be used
their business type.
in calculating quantitative requirements and a stress testing
Figure 5
methodology. In addition, as discussed, NBDTS must address
Maturity profile of $NZ funding within the NBDT
liquidity management in their risk management plans.
sector as at 31 October 2009
In contrast to the approach taken to NBDTs, liquidity
45%
requirements in the banking regime are more prescriptive,
Finance
Companies
40%
35%
30%
BuildingSociety
requiring that large locally incorporated banks meet a
Creditunion
minimum standard. This regime has two main components.
25%
Large locally incorporated registered banks are required to
20%
15%
maintain funding from stable sources, such as retail deposits
10%
5%
or longer-term wholesale funding, at a minimum level (called
0%
OncallͲ EFTPOSOthercall
cheque lesschq
1Ͳ90d
90dͲ1yr
1Ͳ2yrs
2Ͳ3yrs
3Ͳ4yrs
4Ͳ5yrs
5yr+
Source Reserve Bank SSR
the core funding ratio). The current requirement is that 65
percent of the bank’s funding is from stable sources. It is
From the onset of the recent finance company failures and
intended that the core funding ratio be increased in steps to
subsequent diminishing investor confidence, the ability of
75 percent over time. Locally incorporated registered banks
finance companies to raise new funding was limited. Their
must also hold sufficient levels of liquid assets against short-
ability to meet liquidity requirements was predominately
term liabilities, calculated on both a weekly and monthly
dependent on the successful repayment of their loan
basis (the one-week and one-month mismatch ratio).19
book assets. During this period, finance companies within
the consumer financing sector have shown some success
in meeting their financial obligations. However, finance
8
Governance
companies within the property financing sector have been
It is important that the directors of an NBDT act in the best
particularly vulnerable to liquidity shortfalls as their loan
interests of the NBDT. This provides a level of assurance to
book assets have proven to be highly illiquid in a stressed
security holders that their interests will not be prejudiced
market. Savings institutions have continued to enjoy high
in favour of a related entity or individual. Independent
levels of reinvestment and have hence been able to manage
directors are considered the cornerstone of best practice
their liquidity positions.
14
18
19
Deposit Takers (Liquidity Requirements) Regulations
2010. These regulations are promulgated under
section 157Z of the Act.
See Hoskin K, I Nield and J Richardson (2009) “The
Reserve Bank’s new liquidity policy for banks”,
Reserve Bank Bulletin, 71(4)
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
corporate governance, as they are better able to provide
the NBDT sector. The regime is aimed at promoting the
impartial advice and direction to the company, particularly in
maintenance of a sound and efficient financial system. The
dealings with related parties.
Reserve Bank has made substantial progress in implementing
From 1 December 2010, NBDTs that are companies or building
societies must have at least two independent directors and
a chairperson who is not an employee of either the NBDT or
a related party. In addition, NBDTs that are subsidiaries are
prohibited from including in their constitutions provisions
that would allow their directors to act other than in the
interests of the NBDT.20 Similar provisions apply to locally
incorporated registered banks.
this new regime.
The most significant requirements to
date are the capital adequacy requirement, restrictions on
related party exposures and the requirement for NBDTs
to have a credit rating. NBDTs are also required to meet
good practice corporate governance standards, explicitly
agree to a quantitative liquidity target with their trustee
and formulate and abide by a risk management plan. New
legislation is expected to come into force in 2011 providing
requirements for licensing and changes in ownership, fit and
proper person standards and powers of intervention for the
9
Conclusion
Reserve Bank.
A strong non-bank sector is an important part of a sound
The regime for NBDTs is similar to that for banks. However,
and efficient financial system, particularly given the role
the requirements have been tailored to be fit for purpose for
the sector plays in financing activities that banks have not
the NBDT sector. This approach sets minimum prudential
traditionally been involved with.
standards for NBDTs whilst recognising the importance of
The NBDT sector has been through a period of major change
having a diverse NBDT sector that provides niche services to
over recent years. Many finance companies have failed
complement banks.
or otherwise exited the market, with finance companies
exposed to property development suffering a particularly
high rate of failure. Whilst economic conditions have been
difficult, many of the finance companies that failed had
poor risk management and lending practices, inadequate
capitalisation high levels of related party exposures. Savings
institutions have generally had more conservative business
models and have not suffered similar failures as in the
finance company sector.
The NBDT sector’s exposure to the property development
sector is likely to remain greatly reduced, as the model
of retail funding for high-risk exposures has proven to be
unsustainable. The funding of viable projects in the property
development sector will require new funding models better
suited to the financing of higher-risk projects. For example,
a number of private equity-based funding vehicles have been
launched over recent months with the intention of financing
both new and existing property development.
The new regulatory regime for NBDTs, administered by
the Reserve Bank, addresses many of these weaknesses in
20
These provisions are provided in section 157L of the
Act.
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
15
Annex
Comparison
of requirement for banks and NBDTs
!
Policy
Banks
NBDTs
Credit ratings
Banks must maintain a rating for their long-term
senior unsecured New Zealand dollar obligations
payable in New Zealand
NBDTs must maintain a New Zealand dollar,
long-term, issuer rating
Capital
requirements
Total capital must not be less than 8% of total
risk-weighted exposures
Tier 1 capital must not be less than 8% of
total risk-weighted exposures for NBDTs
with credit rating or 10% of total riskweighted exposures for NBDTs without
credit rating
Tier 1 capital must not be less than 4% of total
risk-weighted exposures
Total capital of the banking group must not be
less than $30 million
Deductions
Deductions for assets of little
value in distress of bank or for
equity-like assets
Deductions similar to banking regime but
tailored to NBDT business
Exposure
types
Credit, market and operational
risk
Credit, market and operational risk
Credit risk
Assets
risk-weighted
to
calculate risk-weighted credit
exposures
Assets risk-weighted to calculate riskweighted credit exposures
Risk weights based on either
Basel II standardised model or
advanced bank internal model
Liquidity
Risk weights set by RBNZ
characteristics of NBDT sector
based on
Market risk
RBNZ market risk model
Scalar applied to average of total assets and
risk-weighted assets
Operational
risk
Scalar applied to total assets and
income or banks may calculate
based on internal models
Scalar applied to average of total assets and
risk-weighted assets
Large locally incorporated banks must maintain,
for the end of each business day:
NBDTs and trustees are required to ensure
that trust deeds include quantitative
liquidity requirements
(a)
(b)
(c)
A one-week mismatch ratio of ! 0%;
One-month mismatch ratio of ! 0%;
One-year core funding ratio of ! 65%
(expected to be raised to 75% over
time).
Guidelines are provided on
determine these requirements
how
to
!
16
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
Policy
Banks
NBDTs
Related party
exposures
Credit exposures to non-bank connected persons
shall not exceed of 15% of the banking group’s
tier 1 capital
Aggregate exposures to related parties
must not exceed 15% of the capital of the
borrowing group
Aggregate allowable credit exposures of the
banking group to all connected persons depends
on the rating of the bank
Definition of
related party
Owners: a person holding a
substantial direct or indirect
interest in the registered bank
Owners: a person holding a substantial
direct or indirect interest in a member of
the NBDT group
Sister entities: an entity in which
the owner has a substantial
interest;
Sister entities: an entity in which the owner
has a substantial interest;
Subsidiary/held
entities:
a
(nonguaranteeing) subsidiary or an entity in
which a NBDT has a substantial interest
Directors of the registered bank
Directors and senior office holders of NBDT
group members and their relatives
Interlocking directorships: entities with
40% commonality in governing body
Substantial
interest
means
holding 20% or more of:
•
•
•
•
Credit
exposure
Governance
issued securities;
dividend entitlements;
voting rights;
control
over
composition
of
governing body
Maximum loss incurred if the
related party fails to meet its
obligations
Locally incorporated registered banks must meet
the following requirements:
•
•
•
have at least 2 independent directors;
the chairperson of the board must not
be an employee of the bank;
the bank’s constitution must not allow a
director to act other than in the
interests of the bank
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
Substantial interest means holding 10% or
more of:
•
•
•
•
ordinary shares;
control of the company;
voting rights; or
control >25% of composition of
governing body.
Maximum loss incurred if the related party
fails to meet its obligations
NBDTs
must
requirements:
•
•
•
meet
the
following
have at least 2 independent
directors;
the chairperson of the board must
not be an employee of the bank;
subsidiary NBDT’s
constitution
must not allow a director to act
other than in the interests of the
NBDT
17
References
Reserve Bank of New Zealand (2009) “Risk management
Hoskin, K and S Irvine (2009) “Quality of bank capital in New
programme guidelines”, http://www.rbnz.govt.nz/finstab/
Zealand”, Reserve Bank Bulletin, Vol 72 (3)
nbdt/requirements/3857995.html
Hoskin, K, I Nield and J Richardson (2009) “The Reserve
Deposit Takers (Credit Rating, capital ratio and related party
Bank’s new liquidity policy for banks”, Reserve Bank Bulletin
exposures) Regulations 2010, http://www.rbnz.govt.nz/
Volume 72(4)
finstab/nbdt/requirements/3857852.html
Javier, N (2009) “New legislation for regulation of non-bank
deposit takers”, Reserve Bank Bulletin, Volume 71 (4)
KPMG, (2010) “Financial institutions performance surveynon-banks review of 2009”
Office of the Minister of Finance (2008) “Proposal for new
regulations for non-bank deposit takers: capital, related
party and credit rating requirements” and “Regulatory
impact statement”, http://www.rbnz.govt.nz/finstab/nbdt/
requirements/3857852.html
Reserve Bank of New Zealand, Financial Stability Reports,
http://www.rbnz.govt.nz/finstab/fsreport/
Reserve Bank of New Zealand (2008) “Draft NBDT policies:
related party requirements and minimum capital ratio
requirements”,
http://www.rbnz.govt.nz/finstab/nbdt/
requirements/3857852.html
Reserve Bank of New Zealand (2010) “Know your
credit
ratings”,
http://www.rbnz.govt.nz/finstab/nbdt/
requirements/3857981.html
Reserve Bank of New Zealand (2009) “NBDT capital
policy
paper”,
http://www.rbnz.govt.nz/finstab/nbdt/
requirements/3857852.html
Reserve Bank of New Zealand (2010) “NBDT consultation
document:
liquidity
policy”,
http://www.rbnz.govt.nz/
finstab/nbdt/requirements/3857988.html
Reserve Bank of New Zealand (2010) “Quantitative liquidity
requirements guidelines”, http://www.rbnz.govt.nz/finstab/
nbdt/requirements/3857988.html
Reserve Bank of New Zealand (2009) “Type of credit rating
for non-bank deposit takers: consultation paper”, http://
www.rbnz.govt.nz/finstab/nbdt/requirements/3857981.
html
18
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
Bringing financial stability legislation to the insurance
industry – the Insurance (Prudential Supervision) Act
2010
Richard Dean
Insurers face a number of significant areas of risk in the operation of an insurance business. As well as pure insurance
risk, there are credit risk, investment (or market) risk, liquidity risk and operational risks to consider. Financial weakness or
failure of an insurer can have significant impacts on large numbers of policyholders of all descriptions. In order to properly
protect policyholder interest, it is therefore clear that the financial strength of the insurance industry should be subject to
appropriate prudential regulation.
Until the enactment of the Insurance (Prudential Supervision) Act 2010 (the Act) in September, there had been no previous
comprehensive prudential regulatory regime covering the activities of insurers carrying on insurance business in New
Zealand.1 Now the industry is subject to a world-class regulatory model administered by the Reserve Bank.
This article explores the reasons behind the introduction of the new legislation, its objectives and the Reserve Bank’s
intended approach in achieving these.
1
Introduction
with established international expectations of insurance
Insurance is an important (but not systemic) component of
regulation.2 All our relevant trading partners have well-
the financial services sector in New Zealand. The protection
established and strong regulatory models covering the
provided by insurance is a significant element in the financial
activities of insurers; for example the Australian Prudential
security of individuals and companies in New Zealand, as is
Regulation Authority (APRA) regulates insurance in Australia,
the case worldwide, and the lack of insurance through the
the Financial Services Authority (FSA) in the UK, the Office of
failure of an insurer could have significant impact on those
the Superintendent of Financial Institutions (OSFI) in Canada,
who are directly or indirectly affected. Whilst the failure
the Monetary Authority of Singapore (MAS) in Singapore,
of an individual insurer may not have the same systemic
and there are many state regulatory models in place across
importance in New Zealand as the failure of one of New
the US.
Zealand’s major banks, independent failures within the
Government acknowledged this regulatory shortfall early in
insurance industry would certainly have a degree of impact
the decade and, in 2003 and 2004, the New Zealand Law
on the economy’s security. Accordingly, it is important that
Commission produced reports on life insurance, including
the New Zealand insurance industry is financially stable and
recommendations regarding an overhaul of existing outdated
soundly regulated, and, equally importantly, is seen to be so
legislation and the establishment of a prudential regulator
by external observers.
for the New Zealand insurance sector; ie, a watchdog over
For many years, the New Zealand insurance industry has
the financial stability of insurers carrying on insurance
carried something of a “wild west” reputation, at least as
business in New Zealand.
viewed from overseas. The country had one of the least
Following this report, and as part of its ongoing “Review
regulated insurance markets in the world and, despite
of Regulatory Frameworks”, the government announced
a reasonably effective self-regulatory approach taken
a review of the Regulation of Non-Bank Financial Products
by insurers, New Zealand remained firmly out of line
and Providers (RFPP) in 2005, with the intention of ultimately
1
For details see the Insurance (Prudential Supervision)
Act 2010 and related documents provided in Finance
and Expenditure Committee 2009.
2
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
See Jessup (1990) and Jessup (1998) for earlier
descriptions of insurance supervision and life
insurance law in New Zealand.
19
developing an effective and consistent regulatory framework
overseas, and the model Insurance Core Principles published
and promoting confidence and participation in sound and
by the International Association of Insurance Supervisors
efficient financial markets. This review included the insurance
(IAIS). The Bank had significant regard to these references
sector. Arising from the RFPP was the government decision
which continued to serve as a guide throughout the period
to appoint the Reserve Bank as the prudential regulator and
of preparation of the legislation. In addition, there was
supervisor for insurers.
proactive and extensive consultation with stakeholders from
within the industry as well as related support professions.
2
Designing a new regulatory
The requirement was to design a regulatory model that:
• would promote the maintenance of a sound and efficient
regime
insurance sector and promote confidence in the sector;
A strong Reserve Bank understanding of the New Zealand
insurance industry was a critical factor in the successful
• would achieve this, where possible, in a light-handed
manner;
design of an effective and appropriate regulatory model for
insurers carrying on insurance business in New Zealand. New
• would bring New Zealand into general alignment
Zealand’s population of just over 4 million people is served
with established international standards of insurance
by a diverse insurance industry that currently comprises
regulation;
approximately 160 registered entities that have paid their
statutory deposits as required by the Insurance Companies
• would recognise the realities and idiosyncrasies of the
New Zealand market and maintain the general balance
Deposits Act 1953.3
of the market, including maintaining the interest of
Insurers are split approximately 75 percent non-life (including
medical insurers) and 25 percent life insurers. There are a
large number of small companies and a smaller number of
overseas support; and
• would not unduly restrict the industry from carrying on
its business.
large companies – at least large by New Zealand standards.
(By worldwide standards all insurers operating in New
Zealand are small, and the total New Zealand insurance
market is tiny when viewed in a worldwide context). There
are a large number of companies that are sourced offshore,
some of which exist in New Zealand as locally incorporated
subsidiaries and some as branches of overseas insurers.
There are also a number of indigenous insurers. There are
reinsurers and captive insurers. In summary, the market is
small, comparatively well developed, diverse – and (until
now) virtually unregulated from a prudential perspective.
The creation of a new regulatory model, to apply to an
industry that has never been subject to such regulation, is
not a task that is achieved in a vacuum. The Reserve Bank
3
Existing legislation
Existing legislation that impacts the insurance sector, and is
being repealed wholly or in part and replaced by the new
Act, is as follows:
• the Life Insurance Act 1908
- which
provides
for
rudimentary
reporting
requirements only;
• the Mutual Insurance Act 1955
- which is no longer applicable in New Zealand;
• the Insurance Companies Deposits Act 1953
undertook an extensive review of existing legislation (see
- which requires insurers to maintain a statutory
section 3 below), relevant precedent regulatory models from
deposit of up to $500,000 NZ with the Public
Trustee; and
3
20
See Ministry of Economic Development (2008) for
a list of insurers with a deposit listed at the Public
Trust.
• The Insurance Companies (Ratings and Inspections Act)
1994
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
- which requires property and/or natural disaster
5
The development of the
insurers to obtain and publicise a financial strength
legislation, and support along
rating from a rating agency
the way
A draft Insurance (Prudential Supervision) Bill was released to
4
History of insurer failure in
New Zealand
There have been only a small number of insurer failures in
New Zealand, all of comparatively minor industry and public
impact, including:
stakeholders for consultation in mid-2009. The finalised Bill
was given its first reading in Parliament in December 2009.
During its six-month period at Finance and Expenditure
Committee, the Bill was released for public comment,
generating 61 submissions in response. Following its second
reading in July 2010, and committee stages and third reading
• Maoriland Life (liquidated 1952);
in August, it received the Royal Assent on 7 September
• Standard Insurance Company (1961);
2010 and became the Insurance (Prudential Supervision) Act
• Guarantee Mutual Life (wound up 1980);
• Superannuation Mutual and Tasman Mutual (liquidated
1989);
2010.
The Bill received unanimous cross-party support at all
stages of its progress through Parliament. In addition,
the insurance industry has been generally supportive
• Capital Life (1989); and
through the development phase of the legislation. Broader
• ACL Life Insurance (placed under judicial management
stakeholder engagement has also been strong and a range
1989).
However, the historical infrequency of failure is, of itself, no
of constructive inputs has significantly informed the final
form of the legislation.
guarantee against future failures. The intentions of the new
legislation are:
6
The key features of the
• firstly, to ensure that companies are in a position of
financial strength that renders failure unlikely (without
going as far as to provide a guarantee against failure);
and
legislation
The Act focuses only on prudential regulation – it is
not focused on market conduct issues. Regulation of
market conduct matters is the subject of other legislation,
• secondly (but also importantly) to facilitate the orderly
currently administered mainly by the Ministry of Economic
resolution of distress management situations that
Development and Securities Commission, although much of
may arise, whether by way of directed recovery or by
this responsibility is expected to pass to the (about to be
facilitation of an orderly market exit of the distressed
established) Financial Markets Authority.
insurer.
a. The Reserve Bank’s functions under the Act
It is expected that the great majority of supervisory effort
are to:
will be applied in a ‘business as usual’ focus on the first
• issue licences to qualifying insurers;
intention, with distress management activity being required
only infrequently.
• undertake prudential supervision of licensed insurers;
• take appropriate action in relation to insurers that have
failed, are failing or are likely to fail to comply with the
requirements of the Act; and
• carry out other functions as required by the Act and
regulations.
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
21
b. Licensing, and scope of the Act:
risk, credit risk, liquidity risk and other risks that may be
The Act requires that all persons carrying on insurance
specific to the insurer. Liquidity is a measure of the insurer’s
business in New Zealand must be licensed, and it is an
ability to meet its current day-to-day financial obligations.
offence for an unlicensed person to carry on insurance
For an insurer, this usually means having enough cash readily
business in New Zealand, or to hold itself out as a licensed
available to pay current and near-term claims.
insurer. The definition of “carrying on business in New
Zealand” is subject to certain exclusions, including Crown
or public entities and incorporated societies that provide
insurance only as an incidental service within a broader
primary purpose, and the Act enables the Reserve Bank
to declare certain persons not to be carrying on insurance
business in certain defined circumstances.
The nature of solvency, capital adequacy and liquidity
considerations varies between different categories of insurers.
The fact that life insurance liabilities tend to be longer term
than those of non-life insurance gives rise to different capital
and liquidity requirements. For example, claims on life
insurance are less frequent and tend to occur much further
out into the future than domestic contents or motor-vehicle
The definition of “carrying on insurance in New Zealand”
claims which tend to occur at greater frequency and over a
under the Act is tied to the definition of “contract of
shorter timeframe. In addition, captive insurers, as defined
insurance”. In turn, the definition of “contract of insurance”
by the Act, which are insurers that are wholly owned by a
is subject to a number of exclusions, to minimise the
non-insurer parent company and that insure only the risks of
unintended capture of concepts that are not, in substance,
the non-insurer parent, present different capital and liquidity
insurance for the purposes of the Act. Examples of this
considerations due to the internal financial structure within
include derivative transactions, financial guarantees, product
the parent company.
or service warranties, and Kiwisaver benefits.
The Act allows for the development of as many standards as
The Act does not license insurers that do not carry on
may be required to cover the full range of insurer categories
insurance business in New Zealand. Therefore, overseas or
in an appropriate manner. There are separate standards
New Zealand insurers that do not offer insurance in New
currently in preparation for life insurance, non-life insurance
Zealand are not eligible for licensing under the Act. However,
and captive non-life insurance. Others may be prepared as
the Act does not prevent New Zealand-based residents and
they become necessary.
businesses from seeking insurance outside New Zealand, nor
does it prevent licensed New Zealand insurers that carry on
business in New Zealand from offering insurance in other
countries. Table 1 shows the requirements an insurer must
comply with to be entitled to a licence.
Insurers are required to disclose their solvency position in
their annual financial statements and on their website (if
applicable). In addition, insurers must constantly monitor
their solvency position and report to the Reserve Bank
on any current or future likelihood of breaching required
solvency standards.
c. Prudential regulation of insurers includes:
* Solvency standards (separate standards for life
* Financial strength ratings requirement
insurers, non-life insurers and captive insurers)
Financial strength ratings of insurers are provided by specialist
Key components in assessing the financial stability of an
independent rating agencies, and assess the ability of insurers
insurer are solvency, capital adequacy and liquidity. Solvency
to pay the claims for which they are liable. Ratings have been
is a measure of whether an insurer has adequate assets to
a legislated requirement in New Zealand on the majority of
cover its liabilities. Capital adequacy is a measure of whether
non-life insurers since 1994 under the Insurance Companies
or not an insurer has adequate capital backing to support
(Ratings and Inspections) Act 1994. The new Act extends
the assessed risks to which the insurer is exposed. These risks
the rating requirement to all insurers, with only very limited
include insurance risks as well as investment risk, operational
exceptions (e.g., captive insurers). Financial strength ratings,
22
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
Table 1
Reserve Bank requirements for an insurer to be entitled to a licence
Licensing requirements for each insurer
Rationale
Must hold a financial strength rating from an approved
rating agency
Ratings are a useful independent opinion of the financial
strength of an insurer which can assist policyholders and
prospective policy holders to assess the risks associated
with particular insurers
Has the ability to carry on its business in a prudent manner
Includes considerations of appropriate resources and
internal controls, nature of insurance products offered,
reinsurance arrangements, non-insurance activities and
related party transactions
Has the ability to comply with requirements on solvency
standards, financial strength ratings, risk management,
appointed actuary, financial reporting and statutory funds
Has the ability to comply with any proposed conditions of
licence
­­­
Given the diversity of the New Zealand market it is likely
that many licences will be issued subject to conditions
relating to matters specific to the insurer concerned
Holds and can maintain the required capital specified in the
solvency standards
Adequate capital is the key component in assessing the
financial stability of an insurer
Has and operates an appropriate fit and proper policy
Fitness and propriety of directors and officers are key
determinants in assessing the governance, management
and leadership of an insurer
Has and operates an appropriate risk management
programme
Risks to the financial health of the insurer must be
adequately identified and provided for
Has ownership and governance structures and financial
strength appropriate to the size and nature of its business
The insurer must be adequately resourced, have sufficient
ownership strength and be appropriately governed for the
business it intends to carry on
If the insurer is an overseas insurer, has home-country legal
environment and insurance regulatory requirements that
meet Reserve Bank required standards
Certain recognition may be considered for home-country
regulation of insurers from approved jurisdictions with
appropriate regulatory standards
Is registered under the Financial Service Providers
(Registration and Dispute Resolution) Act 2008
Alignment to other insurance-relevant legislation
Can comply with the Anti-Money Laundering and
Countering Financing of Terrorism Act 2009 if that Act is
applicable to the insurer
An insurer must be able to ensure that its activities do not
unwittingly assist criminal or terrorist purposes
Can comply with any other prescribed requirement
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
23
which must be renewed annually, provide policyholders with
of, insurers’ self-reported financial data. As the majority of
an independent specialist opinion on the financial strength
insurers already contract the services of an actuary – either
of an insurer, and also a useful cross-check on the Reserve
internally employed or an external consultant – this legislated
Bank’s view of the financial stability of insurers.
requirement will not mean a major change for them.
Insurers are required to disclose their ratings to the public in
a prescribed manner. Rating agencies must be approved by
the Reserve Bank, and an insurer may only disclose a rating
provided by an approved rating agency.
*
Financial reporting requirements
To date, public disclosure of an insurer’s financial position
has been limited to financial reporting required under
the Financial Reporting Act 1993 or similar legislation. In
*
addition to current annual public reporting, the Act requires
Risk management requirements
Another key component in the assessment of the current
and likely future financial stability of an insurer is its ability
to properly identify, and then effectively manage, the risks
insurers to provide regulatory reporting to the Reserve Bank
every six months. The annual reporting requirement is more
detailed than the six-monthly reporting.
to which it is exposed. Risk in the insurance context extends
By reviewing formal reporting on a six-monthly basis, as well
well beyond the common perception of insurance risk; i.e.
as requiring the insurer to constantly monitor its solvency
the risks for which the insurer offers insurance. Areas for
position and report to the Reserve Bank on any likely breach,
consideration under this heading also include credit risk,
the Reserve Bank will maintain a close and effective watch
investment (or market) risk, liquidity risk and operational
over the financial position of each insurer and thereby the
risk. The Reserve Bank requires an insurer to demonstrate
industry as a whole.
the extent of its risk awareness as well as its documented
approach to the management of such risks.
As with all prudential data reported by insurers to the Reserve
Bank, the regulatory material provided in these reports will
The nature of risk can vary widely between categories of
remain confidential between the insurer and the Bank.
insurer as well as individual insurers within each category.
Therefore, there is no fixed template model for risk
assessment that can apply generally to all insurers. The risk
*
Statutory
fund
requirement
for
life
approach of each insurer will be assessed individually by the
insurers
Reserve Bank.
Life insurance liabilities tend to be long-term in nature,
and therefore the assets that cover those liabilities must be
preserved to ensure adequate coverage of the liabilities right
*
Appointed actuary requirement, including
through to their settlement. However, day-to-day operational
the financial condition report
requirements of a life insurer may be much shorter-term in
The assessment of insurance liabilities, in addition to many
nature, and there is therefore the necessity to protect long-
other insurance–specific concepts and calculations, is
term liabilities from being undermined by supporting assets
the specialist territory of an actuary. The Act requires that
being stripped out to cover short-term requirements.
all insurers (with very limited exceptions) must have an
appointed actuary as one of their relevant officers, and the
responsibilities of the appointed actuary are clearly stated in
the legislation.
The Act requires life insurers to establish a statutory fund
vehicle within their accounts. This is a means of ring-fencing
all assets and liabilities relating to the life insurance business
to ensure that they are only available for use in respect of
The involvement of an actuary in specialist areas is important
the life insurance business. All life insurance revenues and
in increasing public and regulatory confidence in the
appropriate asset coverage must be credited to the fund (or
methodology and consistency supporting, and the accuracy
funds) and all liabilities must be paid from the fund. The
24
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
fund may not contain anything that does not relate to the
e. Distress management provisions include:
life insurance business of the insurer.
*
A number of life insurers already operate a ‘life fund’ model,
If an insurer is failing to maintain solvency requirements, or
so the requirement under the Act for the establishment
fails to comply with any direction of the Reserve Bank, or
of at least one statutory fund will not mean a significant
its business is not being conducted in a prudent manner,
operational change. However, the legal status of the
the Act empowers the Reserve Bank to direct an insurer
statutory fund under the legislation is enhanced and,
to prepare a recovery plan that must be satisfactory to the
therefore, the protection of life policyholder funds will be
Reserve Bank. The recovery plan must set out actions and a
significantly increased.
timetable toward the achievement of a compliant position
Recovery plans
and the maintenance of that position.
d. Prudential supervision provisions include:
*
Information gathering
The Act includes broad information-gathering powers
empowering the Reserve Bank to seek and obtain information
from insurers, associated persons and other persons in
respect of any matters relating to the business, operation or
management of the insurer. Such information must be used
for the purposes of prudential supervision. This informationgathering power applies to all insurers at all times, not
limited to situations of actual or suspected insurer distress.
The Reserve Bank may require that information provided to
it be independently reviewed for verification.
This power enables the Reserve Bank to remain fully aware of
*
Giving of directions to licensed insurers
The Act gives the Reserve Bank broad direction-making
powers to require an insurer to carry out, or refrain from
carrying out, certain actions in the event of certain failures,
transgressions or situations of breach. Directions are wide
ranging, from requiring the insurer to consult with the
Reserve Bank on certain issues right through to requiring the
insurer to cease to carry out its business or a part thereof.
The Reserve Bank may also issue directions to associated
persons of an insurer in certain circumstances.
There are significant penalties for failure to comply with the
requirements relating to recovery plans and directions.
an insurer’s position at all times, without having to wait until
six-monthly formal reporting dates specified elsewhere.
*
Removal, replacement or appointment of
key officers
*
Investigations
In circumstances similar to those that give rise to the
If the Reserve Bank has cause to suspect that an insurer
requirement for recovery plans or the giving of directions,
is failing to maintain solvency requirements, or is not
the Act empowers the Reserve Bank to remove, replace, or
conducting its business in a prudent manner, or is operating
appoint directors, the auditor or the appointed actuary of
fraudulently or recklessly, or has failed to supply information
the insurer.
or supplied false information (this also applies to associated
persons of the insurer), or an insurer is failing to comply
with any direction of the Reserve Bank, the insurer may be
required to supply information either direct to the Reserve
Bank or to an investigator appointed by the Reserve Bank to
obtain such information.
*
Reserve Bank may apply for the liquidation
or voluntary administration of licensed insurers
In cases of severe insurer distress, the Act empowers
the Reserve Bank to seek the liquidation or voluntary
administration of an insurer. The Reserve Bank retains a
There are significant penalties for failure to comply with
the requirements under the information gathering and
investigation provisions.
wide range of rights to participate and be represented at
proceedings during the period of liquidation or voluntary
administration.
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
25
•
Reserve Bank may request the appointment
8
Format of the legislation
of a statutory manager to a licensed insurer
Formal documentation relating to this legislation will
In the most severe cases of insurer distress or non-compliance,
comprise:
and where such issues may cause significant damage to the
financial system or the economy of New Zealand, or where
• the Act (the primary legislation);
the insurer is acting fraudulently or recklessly, the Reserve
• regulations attaching to the Act, which have the force
Bank may recommend that the Minister of Finance request
of law. Solvency Standards and Fit and Proper Standards
the Governor General to place an insurer or an associated
(and possibly others in the future) will be deemed
person of the insurer into statutory management, and
regulations attaching to the Act; and
appoint a person as statutory manager of the insurer. The
• guidance notes. These do not have the force of law, but
Reserve Bank powers in this respect are broadly similar to
are intended to explain the Reserve Bank’s expectations
those in the Reserve Bank Act 1989 and the Corporations
behind the various legislative requirements as well
(Investment and Management) Act 1989.
as how to complete documentation relating to the
administration of the Act.
7
Implementation programme
The Act was passed into law on 7 September 2010. Certain
The required regulations and guidance notes are currently
under preparation.
provisions commenced immediately upon enactment and
a number of operational provisions will commence on 1
February 2011. Provisions relating to licensing requirements
and the repeal or amendment of existing legislation become
effective on 7 March 2012; ie, 18 months following
9
Reserve Bank intentions and
expectations
The delivery of brand new legislation into a previously
unregulated sector is inevitably a complex task. Delivery
enactment.
of the Insurance (Prudential Supervision) Act 2010 is no
All insurers are now required to move through the licensing
exception.
process. Full compliance with all requirements of the Act
will not be possible for any insurer immediately upon
enactment and, therefore, there will be a transitional
path to compliance available to insurers that will last for a
maximum of three years from the date of enactment. Upon
application and evidence of satisfactory compliance with
initial requirements, insurers will be issued with a provisional
licence that will contain conditions detailing their required
path to full compliance with the requirements of the Act.
All insurers must have a licence by 7 March 2012, whether
this is a provisional or a full licence. All insurers must be fully
compliant with the requirements of the Act, and therefore
be fully licensed, by 7 September 2013. Any insurer that
does not meet either of these licensing requirements by
The Reserve Bank has clear objectives in the delivery and
implementation of the Act. In addition to the stated purpose
of the legislation, which is to “promote the maintenance of
a sound and efficient insurance sector and promote public
confidence in the sector”, the Reserve Bank expects the
following outcomes from this legislation:
• an ongoing principles-based and outcome-focused
approach to regulation;
• an efficient style of prudential supervision that does not
unnecessarily disrupt industry;
• an efficient transitional path toward full licensing for the
industry;
the required dates will be in breach of the Act and will be
• a general raising of industry standards, especially in
required to cease carrying on insurance business in New
the areas of risk management and corporate financial
Zealand.
understanding;
• clear recognition of the obligations upon directors and
26
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
senior officers and the importance of their contributions
Insurance (Prudential Supervision) Act (2010) sections
to corporate outcomes;
6-11 – interpretation, http://www.legislation.govt.nz/act/
• a generally raised public perception of the New Zealand
insurance industry, both within New Zealand and
overseas; and
• better information about the financial strength of
insurers available to policyholders.
public/2010/0111/latest/DLM2478115.html, accessed 30
November 2010.
Jessup, R A (1990) “Supervision of life insurers in New
Zealand”, paper presented at the New Zealand Society of
Actuaries Conference, Mt Ruapehu, November.
Jessup, R A (1998) “Life insurance law in New Zealand”,
paper presented at the New Zealand Society of Actuaries
References
Finance and Expenditure Committee (2009) Insurance
(Prudential Supervision) Bill 2009 and related documents,
from
http://www.parliament.nz/en-NZ/PB/Legislation/
Bills/f/4/5/00DBHOH_BILL9659_1-Insurance-Prudential-
Conference, New Zealand, October.
Ministry of Economic Development (2008) List of insurers
with a deposit lodged with the Public Trust, from http://www.
isu.govt.nz/templates/ContentTopicSummary____22738.
aspx, Wellington, October.
Supervision-Bill.htm, accessed 30 November 2010.
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
27
Global currency trends through the financial crisis
Zoe Wallis, Financial Markets Department
In this article, we examine trends in the global and NZD foreign exchange (FX) markets over the recent financial crisis
period from 2007 to 2010, identifying key changes in the nature of FX trading. These trends are examined using the most
recent Bank for International Settlements (BIS) triennial survey as well as other data sources and market intelligence. The
survey shows that, overall, the volume of global FX turnover has increased over the last three years. Demand for safehaven currencies such as the US dollar and Japanese yen have increased through the crisis. The NZD’s share of global
turnover has decreased in an environment of increased risk aversion and volatility, and investor interest in trading the NZD
has waned. Demand for carry trades, particularly in NZD, has fallen in an environment of increased volatility.
1
Introduction
causing currency traders to prefer relatively more liquid
The recent global financial crisis commencing in 2007
currencies and, overall, take a more cautious approach to
has caused a significant shift in the nature of trading in
trading. Turnover in the NZD as a share of global FX turnover
FX markets. The types of FX-rate instruments traded, the
has decreased over the crisis, driven by the decline in risk
volume of currency market transactions and the types
appetite and lower New Zealand interest rates. This has also
of investors trading have all changed in response to the
seen a paring back in previously popular carry trade positions
increased volatility and decreased risk appetite that has been
in the NZD, further reducing trading in the currency.
observed over the crisis period.
This paper utilises data from the BIS Triennial FX Turnover
survey, which provides comprehensive data on global
turnover in the FX market, and the latest survey covers the
past three years from April 2007 to April 2010, allowing
for pre- and post-crisis comparison. The data is compiled
from surveying 1309 individual banks and other dealers,
asking questions about turnover in FX and over-the-counter
(OTC) derivatives. A total of 53 central banks and monetary
authorities collated the data and the results are then reported
to the BIS. This survey provides an overarching view of trends
in foreign exchange trading over the past three years that
2
Trends in global foreign
exchange markets
The financial crisis began in mid-2007 and then escalated
with the collapse of Bear Sterns in May 2008 and Lehman
Brothers filing for bankruptcy in September 2008. The
recent crisis is commonly viewed as the worst since the
Great Depression in the 1930s, and has had a major impact
on financial markets. Foreign exchange markets have
experienced a period of reduced market liquidity, increased
volatility and an increased focus on counterparty risk.
is particularly useful for understanding trends in currency
The crisis caused investors to reassess many of the trades that
trading across this period. The article begins by discussing
were predicated on a low volatility and low risk environment
some of the changing trends seen in global currency markets
and were popular over 2004-07. Safe-haven demand for
over the crisis period and the nature of some of the most
currencies such as the US dollar increased as traders began
popular trades. We then turn our attention to the impact of
to take a more cautious approach towards investing. Traders
the crisis on trading trends in the NZD market.
around the world reported a lack of liquidity in FX markets
The article finds that, while overall global turnover volume
has continued to increase through the recent financial crisis,
the increase was at a slower pace than that seen over the
previous three years from 2004 to 2007. Risk appetite
declined over the crisis and volatility in FX markets increased,
28
during the height of the crisis and there were often volatile
swings in currency rates, which increased the risk of trading
even further. Even though the absolute volume of currency
transactions has increased and currency markets continued
to become more globalised, the crisis has slowed the strong
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
growth in trading that was seen over 2004-07. There is now
the question as to whether markets will return to the same
level of risk taking as seen prior to the collapse of Lehman
Brothers, or whether we will see a ‘new normal’ where
markets settle at a lower level of risk taking compared to
pre-crisis.
the sizeable risks on the downside.
Traders also were increasingly constrained by tighter trading
limits, due to the technical way risk is monitored at most
financial firms. Typically, banks use a measure called ‘Value
at Risk’ (VAR), which is assessed using historical data and
based on probability of losses over a certain time-frame. As
Markets started to stabilise as confidence began to
the historical data began to include the crisis period, the
recover in March 2009. By this stage, central banks had
increased historical losses heightened the risk associated with
undertaken significant monetary policy easing and provided
most assets. This caused downwards revisions to position
additional liquidity measures to further support markets and
limits, further restraining the size of positions and level of
economies.
risk traders could take. Many investors had to quickly close
This period of relative calm continued more or less
uninterrupted until financial markets expressed doubts
about the sustainability of sovereign debt at the end of
2009 and concern escalated rapidly in early 2010. These
doubts led to the European Union and the IMF forming the
European Financial Stability Fund (EFSF) as a back-stop for
European governments struggling to raise funding and also
a separate emergency funding package for Greece. Recently,
concerns over European sovereigns have re-emerged, again
down positions, which caused greater volatility in markets.
From the end of 2008, traders pared back positions in
higher-yielding currencies (yields such as New Zealand and
Australia) in a ‘flight-to-safety’. This was in stark contrast to
the boom period of 2004-07 when volatility was low and
traders were keen to take on additional risk. After many years
of prolonged strong risk appetite, the almost simultaneous
shift in market positioning exacerbated currency moves and
further increased market volatility.
prompting an increased demand for safe-haven currencies
Figure 1
such as the US dollar and Japanese yen.
Deutsche Bank FX volatility index
Moreover, the recovery in the US appeared to stall somewhat
25
during mid-2010 and markets were volatile as participants
20
become nervous about growth prospects. In response to
Deutsche Bank FX volatility index
persistently elevated long-term unemployment and the
risk of deflation, the Federal Reserve introduced a second
15
10
round of asset purchases in early November, further easing
monetary policy.
5
0
Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
Changes in risk sentiment and volatility
Source: Bloomberg
During the lead-up to the financial crisis, there was a marked
increase in the amount of FX turnover, aided by a period of
Counterparty risk and market liquidity
low volatility and a relatively high appetite for risk. These
Since the news of Bear Sterns first disclosed sizeable hedge
factors reversed during the recent financial crisis when
fund losses in mid-2007, traders became somewhat more
traders became increasingly risk averse and market volatility
cautious over the rest of 2007, but over the start of 2008
spiked higher, particularly at the end of 2008 (see figure 1).
markets were beginning to return to normal and it was not
This increase in volatility in the FX market meant that sharp
until the failure of Lehman Brothers that markets experienced
swings in the currency created the potential for both larger
a dramatic loss of confidence. Following Lehman Brothers’
gains and losses. Traders tend to pare back the size of their
bankruptcy, liquidity in financial markets fell substantially.
positions during periods of high volatility in order to avoid
The collapse of Lehman Brothers raised considerable
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
29
concerns about the flow-on effects to other banks and
Spot FX transactions involve the simple exchange of one
other institutions that may be vulnerable. This increased the
currency in return for another at the prevailing (spot)
perceived counterparty risk, and traders became much more
exchange rate at the time of the transaction. While the spot
concerned about who was holding their money on the other
rate is agreed at the time of the transaction, the transaction
side of trades. As volatility and counterparty risk increased,
will be settled (exchange of funds) in two business days
the spread between bid and ask quotes widened and market
under market conventions, hence they are relatively short
liquidity fell as traders dealt in smaller amounts. Interestingly,
term and the amount of counterparty risk is typically small.
the crisis period still saw an increased amount of FX turnover
Spot transactions as a share of trading increased from 30 to
despite smaller trade sizes. Many market participants have
37 percent of the market.
attributed this to a ‘hot potato’ effect, where traders were
keen to pass on any risk as quickly as possible.
FX rate swaps are one of the most commonly traded
instruments and involve two transactions, one at initiation
This ‘hot potato’ trading is likely to have been one of the
where one currency is purchased at the current spot rate and
driving factors behind the increase in FX turnover despite
a second where the initial transaction is reversed at a specified
the increased risk factors associated with trading over this
future date at an agreed exchange rate. This trade involves
period. The BIS survey shows the total amount of global
a much greater level of counterparty risk, as payments are
currency turnover increased by 20 percent from April 2007
made at the end of the contract period (often three months
to April 2010, rising to an average daily turnover of US$4.0
or longer). The trade is based on interest rate differentials in
trillion (figure 2). However, this increase is well down on
different economies and is commonly used to match cash
the 72 percent increase that was seen between 2004 and
flows with the delivery of imports or exports, or by traders to
2007.
take a view on relative interest rate movements.1
Figure 2
Over 2007 to 2010, the percentage of FX swaps declined
Daily average global FX turnover
from 52 to 44 percent. As the financial crisis started to
(Average daily turnover for April of each
escalate, spreads in the FX swap market widened out
reported year)
considerably and by more than the moves seen in spot rate
spreads.2
USD billions
4,500
4,000
In December 2007, the US Federal Reserve, European Central
3,500
Bank (ECB) and the Swiss National Bank (SNB) agreed to
3,000
establish reciprocal FX swap lines to provide the ECB and
2,500
SNB with US dollars. The amounts available via these swap
2,000
1,500
lines were then further extended in March 2008 and in May
1,000
these lines were increased even further to a total of $50
500
0
1998
2001
2004
2007
2010
Source: Bank of International Settlements Triennial Central
Bank Survey 2010.
billion for the ECB and $12 billion for the SNB. Following the
collapse of Lehman Brothers in 2008, these swap lines with
the ECB and SNB were more than doubled and new swap
lines with many of the other major central banks, including
Common types of FX transactions
the Reserve Bank of New Zealand (RBNZ) were introduced.3
Looking into the types of trades that were conducted
A swap line to the RBNZ was established at the end of
over the crisis period, figure 3 shows there was a broad
October 2008 for an amount of up to US$15 billion. These
move towards shorter-term currency instruments. Shorter-
swap arrangements continued until expiry on 1 February
term instruments typically have a lower level of associated
counterparty risk and the likelihood of your counterparty
1
collapsing is reduced the shorter the trading period.
2
30
See Smyth (2005) and Rosborough (2001) for further
discussion of traded FX instruments.
See also Baba and Packer (2009).
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
2010, but temporary lines were later re-established with
Figure 3
some central banks in response to shortages of US dollar
Percentage share of turnover traded in different
funding in May 2010.
FX instruments
Trading of outright forward FX increased marginally over the
100%
Currency swaps
90%
Other FX
derivatives
FX swaps
past three years, rising from 11 to 13 percent of the share
80%
of trading activity. Outright forward FX is typically used if
60%
Outright forwards
50%
Spot
traders want to lock in an exchange rate at a future point
in time, rather than conducting the transaction in the spot
70%
40%
30%
20%
market at the time. The trade occurs in a very similar manner
to a spot trade, but the settlement will occur at a set date
in the future at a rate agreed upon today. The trades allow
a party to lock in a known forward exchange rate and are
10%
0%
1998
2001
2004
2007
2010
Source: Bank of International Settlements Triennial Central
Bank Survey 2010
often used by exporters to hedge their exposure to moves
Increase in financial market correlation
in the currency. As currencies fluctuated violently, forward
Also a striking factor of the recent financial crisis has been
rates helped reduced some of the volatility for imports
the high correlations between movements in a wide range of
and exporters by giving them known exchange rates for a
asset classes. Over the past few years, the general flight-to-
future date; however the spreads on these instruments also
safety trend has seen equity, commodity, bond and currency
widened out significantly following the collapse of Lehman
market movements remain highly correlated (figure 4). The
Brothers.
movements over the crisis period have been predominantly
Less frequently traded are FX options and currency swaps
and the percentage share of trading in these instruments
has remained relatively unchanged at around 7 percent. FX
options give the holder of the contract the right, but not the
obligation, to buy or sell a currency at a pre-determined rate.
Currency swaps are where two parties exchange streams of
interest rate payments in different currencies for a set period
of time and also transfer the principal at maturity at an
agreed exchange rate.
driven by risk appetite and, when this declined, there was a
broad sell-off in risky assets, largely indiscriminate of some
of the underlying fundamentals for different assets.
Figure 4
Equity and commodity prices and the US dollar
Index
240
S&P 500
220
CRB commodity index
200
USD TWI (inverted, RHS)
Collapse of
Lehman
Brothers
Index
60
180
160
140
120
100
80
60
40
70
80
90
100
110
120
130
Source: Bloomberg
Increased trading in safe-haven currencies
The flight-to-safety saw increased trading in currencies
that were viewed as safe-havens, such as the US dollar and
Japanese yen. Trading in the euro also gained through 2008
and 2009 from demand to use the currency as a safe haven
3
Bank of Japan, Bank of England, Bank of Canada,
Reserve Bank of Australia, Svergies Riksbank,
Denmark’s National Bank, Norges Bank, Banco
Central do Brasil, Banco de Mexico, Bank of Korea
and the Monetary Authority of Singapore.
and as investors looked to diversify their portfolios. This
changed when European sovereign debt concerns emerged
at the end of 2009.
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
31
Table 1
Percentage of daily average FX turnover divided by currency
2001
2004
2007
2010
US dollar
89.9
88.0
85.6
84.9
Euro
37.9
37.4
37.0
39.1
Pound sterling
13.0
16.5
14.9
12.9
Japanese yen
23.5
20.8
17.2
19.0
Canadian dollar
4.5
4.2
4.3
5.3
Australian dollar
4.3
6.0
6.6
7.6
New Zealand dollar
0.6
1.1
1.9
1.6
Other
26.3
26.0
32.4
29.8
Source: Bank of International Settlements Triennial FX Turnover Survey
The US dollar has remained the most commonly traded
given the heightened risk that sharp currency moves could
currency by far, although across the past nine years the
wipe out any interest rate gains.
popularity of the US dollar (USD) has decreased slightly and
the euro has increased as its popularity as an intermediary
currency increases. Table 1 shows that, over the past three
years, 28 percent of all trades occurred in the USD/EUR cross
and almost 85 percent of all trades in a USD cross of some
form (Table 1). 4 Safe-haven demand and the reversal of carry
trades have seen the proportion of trading in the Japanese
yen increase. The share of FX transactions conducted in the
NZD has fallen, while turnover in the Australian dollar has
continued to increase. This may be due to the Australian
dollar being used as a proxy trade, allowing investors to bet
on the outlook for Asian growth (given close ties between
Australian and Asian economic prospects), and also a higher
level of interest rates in Australia attracting investors back
into the currency as financial markets began to improve in
Starting in August 2007, there was a large-scale unwinding of
carry trade positions as investors reduced the amount of risk
on their books. This initial unwind was relatively short-lived,
but was later followed by a second round of deleveraging
later following Lehman Brothers’ collapse in 2008 (see figure
5, which shows long positions held by Japanese margin
traders). Since hedge fund trading is often leveraged, as
losses started accumulating during the crisis, funds would be
called upon to deliver additional cash to the broker or close
out their positions. With cash hard to come by, many hedge
funds had to close down large positions, exacerbating the
moves in currencies and further heightening the risks of
the carry trade. However, these liquidations were relatively
small scale compared to those seen following the collapse of
Lehman Brothers in September 2008.
2009.
Figure 5
Net long positions held by Japanese margin
Decline of the carry trade
The carry trade, (where investors borrow in a low-yielding
traders
currency and use the funds to buy assets in a high yielding
Millions of
contracts
480,000
currency) has diminished in popularity in the environment of
430,000
increased risk and uncertainty. The volatile moves in currency
380,000
330,000
markets seen over the past three years have significantly
280,000
reduced the appeal of the carry trade investment strategy,
180,000
GBP
NZD
EUR
AUD
USD
230,000
130,000
80,000
30,000
4
32
Because two currencies are involved in each
transaction, the sum of the percentage shares for
individual currencies sums to 200 percent instead of
100 percent.
-20,000
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Source: Tokyo Financial Exchange, RBNZ
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
Carry trade activity was also scaled back by retail investors
NZD turnover
during the crisis, as can be seen in the levels of margin
Total market turnover in the NZD FX market has declined
trading. Margin trading is a popular form of the carry trade,
somewhat from a percentage share of around 1.9 percent
often undertaken by Japanese investors, where investors put
of total market volume down to around 1.6 percent (see
down a ‘margin’ with a currency broker in order to trade a
Figure 6). Overall, the level of trading in the NZD has
leveraged position in foreign currency. During the past year,
increased marginally. A slight increase in the amount of spot
the overall level of Japanese margin positions has increased
transactions (see figure 7) has offset declines in the trading
almost back to levels last seen in mid-2008, with the record
of other currency instruments such as forward contracts.
5
low levels of interest rates in the US, accompanied by the
expectation of rates remaining low for an extended period
Figure 6
of time, attracting investors back into carry trade positions.
Percentage of average daily turnover in NZD
Despite this, the level of margin trading in the NZD has
remained very subdued.
%
2.0
1.8
1.6
NZD turnover as a percentage of
all currencies
1.4
1.2
3
Trends in NZD FX markets
The 2004-07 period was characterised by an increase in
investor risk appetite. This saw increasing investment in
the NZD as traders searched for yield and showed a strong
preference for higher-yielding currencies. The carry trade
1.0
0.8
0.6
0.4
0.2
-
1998
2001
2004
2007
2010
Source: Bank of International Settlements Triennial Survey
was a favoured investment with offshore investors, as well
as strong demand for NZD-denominated bonds. Trading in
The NZD has historically been a high-yielding currency
these markets subsequently declined during the crisis as
with comparatively high interest rates compared to other
increased volatility and declining New Zealand interest rates
developed economies. In the lead-up to the financial crisis,
reduced the appeal of these trades.
these high returns attracted offshore investors to deposit
funds in New Zealand, increasing demand for the NZD.
NZD levels
In terms of levels, the NZD depreciated from the start of
2008, falling over 15 percent on a trade weighted index
(TWI) basis. The NZD continued to decline until March 2009
The carry trade was particularly popular but many of these
trades were exited when the crisis hit. There has been little
evidence of the carry trade returning to anywhere near
the same volumes as before the crisis. This was one of the
factors driving the decline in turnover in the NZD.
when financial markets reached a turning point. The US
dollar strengthened as global investors flocked to the safehaven currency and US investors repatriated their assets
back into their home currency. Overall, however, the NZD
is at similar levels, both against the US dollar and on a TWI
basis, to those seen in April 2007 when the last BIS survey
was completed.
The broad increased level of volatility in markets since the
start of the crisis has also driven a broad demand for safehaven currencies such as the US dollar and Japanese yen.
The NZD has received less attention from traders since the
start of the crisis, particularly as other commodity-linked
countries, such as Australia, began to raise official policy
interest rates, attracting investment into the Australian dollar
rather than back into the NZD, where the Official Cash Rate
(OCR) remained on hold for a longer period of time.
5
See Cassino and Wallis (2010) for a more detailed
description.
While the level of interest in trading the NZD as a percentage
of global foreign exchange trades has declined, the level of
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
33
spot trading in the NZD has increased steadily since 1998
Figure 7
(see figure 7). The aggregate global turnover data shows
Turnover of spot transactions in NZD and
that, over the past three years, the amount of spot FX
turnover of currency swap market in NZD
transacted has continued to grow, albeit at a slower pace
(figure 9). However, the overall level of derivatives traded in
USD millions
25000
NZD markets has fallen in recent years, possibly related to
20000
the reduced interest in carry trades.
15000
The exception to this has been an increase in the turnover of
10000
currency swaps, which have risen by around 40 percent. This
5000
adds to a sizeable increase of 370 percent between 2004
0
Spot
and 2007. The increase over 2004 to 2007 was probably
due to a large-scale increase in offshore issuance of Uridashi,
Eurokiwi and Kauri bonds, the proceeds of which would
1998
2004
2007
2010
600
Currency swaps
500
then have been swapped back into the local currency.
2001
USD millions
700
400
Recently, issuance of these NZD offshore bonds has been
300
very subdued.
200
100
The increase in currency swaps between 2007 and 2010
may be due to an increase in the term of bank funding as
banks act to lock in longer-term financing. The cash raised
0
1998
2001
2004
2007
2010
Source: Bank of International Settlements Triennial FX
Turnover Survey
in offshore markets is then likely to have been swapped back
into NZDs via currency swaps. There may also be somewhat
of a timing issue, as in April when the 2010 measure was
taken, local banks were relatively active in trying to raise
longer-term funding, more so than they may have been over
2007-2009.
NZD carry trading remains subdued
Positions in NZD/JPY started to be unwound in August 2008
and the NZD/JPY exchange rate declined over 40 percent
to February 2009. Interest in the NZD as a margin trade
instrument appears to have substantially dissipated; a factor
The currency swap market is a very small percentage of total
trading in NZDs (less than 1 percent) however. The majority
of NZD trading is conducted in the FX swaps market, which
involves swapping the principal amount of the trade at
both the initiation and conclusion of the trade. The volume
that is likely adding to a lack of liquidity in the NZD market.
Figure 8
Net long NZD positions held by Japanese margin
traders
of NZD FX swaps declined by around 5 percent between
Thousands of
contracts
240
2007 and 2010 as the attractiveness of NZD trades based
200
NZD/JPY
100
Net long positions (LHS)
90
NZD/JPY (RHS)
on interest rate differentials diminished, with interest rates
160
80
in other developed economies rising above those offered in
120
70
New Zealand. The preference for banks to issue longer-term
80
60
40
50
funding has also seen a switch in turnover from rolling over
a large volume of short-term FX swaps, moving into the
currency swap market instead.
34
0
Aug-06 Feb-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10
40
Source: Tokyo Financial Exchange
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
Historically, New Zealand has had relatively elevated levels of
Liquidity in the NZD market
interest rates even compared to other high-yielding countries
During the crisis, liquidity in the New Zealand dollar market
such as Australia (figure 7). This attracted considerable
became very thin which caused a sharp widening in the
inflows of capital in the lead-up to the financial crisis and
quoted bid-offer spreads (see Figure 10), particularly just
made the carry trade very attractive. Since early 2008, New
following the collapse of Lehman Brothers bank. While the
Zealand interest rates have fallen below those in Australia, a
bid-offer spread has narrowed again, the spread remains
phenomenon not seen since the end of 1995. Since 2000,
slightly elevated compared to post-crisis levels and the New
the interest rate spread between New Zealand and the US
Zealand dollar spread remains above those in other major
has also widened, reaching a peak of almost 500 basis points
currencies. In an environment of increased volatility, this
prior to the start of the crisis. This widening encouraged
may remain a disincentive for some investors trading NZD.
investors to buy NZDs and take advantage of the attractive
The spread on the Australian dollar has historically always
rates of return offered in New Zealand.
been below that of the NZD, illustrating the greater relative
liquidity of the Australian dollar market.
Figure 9
Interest rate differentials for New Zealand versus
Figure 10
Australia and the US
Bid-offer spreads for NZD and AUD
%
11.5
NZ and Australian 5yr swap yields and spread
Bps
300
NZ-AU spread (RHS)
NZ swap yield
AU swap yield
10.5
9.5
250
200
150
8.5
100
7.5
50
6.5
0
12
AUD/USD spread
NZD/USD spread
10
8
6
-50
5.5
4
-100
4.5
-150
3.5
Sep-91 Mar-94 Jul-96 Oct-98 Dec-00 Feb-03 Apr-05 Jun-07 Aug-09
-200
%
10
Basis points*
14
NZ and US 5yr swap yields and spread
Bps
600
2
0
May-07 Oct-07 Mar-08 Aug-08 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10
*In this context a basis point represents 0.01 of a cent
Source: Reuters, RBNZ
NZ-US spread (RHS)
9
NZ swap yield
8
500
US swap yield
7
400
300
4
200
During the recent financial crisis, an increase in volatility and
100
risk aversion in financial markets has prompted changes
6
5
4
3
2
1
Sep-91 May-94 Nov-96 Mar-99 Aug-01 Dec-03 Mar-06 Jul-08
0
Oct-10
Source: Bloomberg.
Summary and conclusions
in the nature of foreign exchange market trading over the
past three years. Overall, daily FX turnover has continued to
increase, albeit at a slower rate than seen in previous years.
With interest rates in Australia and other commodity-linked
currencies, such as the Brazilian real, now relatively more
attractive compared to interest rates in New Zealand, the
During the crisis, risk appetite waned and increased volatility
has seen large positions scaled back with increased demand
for relatively more liquid safe-haven currencies.
carry trades that are still being undertaken have tended to
focus on these economies rather than in New Zealand.6 This
may have contributed to the decrease in FX turnover in the
NZD market, with the percentage share of NZD trades falling
to 1.6 percent in 2010 from 1.9 percent in 2007.
While the US dollar remains the most commonly traded
currency, its popularity has declined in favour of the euro
and Japanese yen, particularly as these markets have become
more liquid and international markets have diversified.
While the US dollar remains the standard transactional and
6
See Cassino, E. and Wallis, Z. (2010) ‘The New
Zealand dollar through the global financial crisis’
Reserve Bank of New Zealand Bulletin, vol. 73, No.
3, 20-29 for further discussion on carry trades.
intermediary currency, the euro and Japanese yen have also
become increasingly popular, taking some of the US dollar’s
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
35
share of market turnover. The NZD share of total trading
Appendix
turnover has declined over the past three years after rising
Currency mnemonics
steadily since 1998.
These are the symbols for national currencies that are
The popularity of the carry trade has decreased as increased
volatility reduced the appeal of this strategy and the NZD has
routinely used by FX traders:
AUD Australian dollar
to be seen whether, as markets gradually return to an
BRL
Brazilian real
environment of lower volatility and increased risk appetite,
CAD
Canadian dollar
CHF
Swiss franc
CZK
Czech koruna
DKK
Danish krone
EUR
Euro
activity in April 2010 – preliminary results”, Monetary and
GBP
Great British pound
Economic Department, Bank for International Settlements,
HKD
Hong Kong dollar
IDR
Indonesian Rupiah
INR
Indian rupee
Zealand Bulletin, 73(3), pp. 20-30.
JPY
Japanese yen
Melvin, M and M P Taylor, (2009) “The Crisis in the
KRW
Korean won
Foreign Exchange Market”, CESifo Working Paper No.
MXN
Mexican peso
NOK
Norwegian krone
NZD
New Zealand dollar
Reserve Bank of New Zealand Bulletin, 64(4), pp. 19-35.
PLZ
Polish zloty
Smyth, N (2005) “Recent trends in foreign exchange
RUR
Russian rouble
SEK
Swedish krone
SGD
Singapore dollar
THB
Thai baht
TWD
Taiwanese dollar
USD
United States dollar
ZAR
South African rand
become less of a focus for international traders. It remains
the popularity of the NZD will return to pre-crisis levels.
References
Bank for International Settlements (2010) “Triennial Central
Bank Survey: Foreign exchange and derivatives market
Basel, Switzerland.
Cassino, E and Z Wallis, (2010) “The New Zealand dollar
through the global financial crisis”, Reserve Bank of New
2707. Available from http://papers.ssrn.com/sol3/papers.
cfm?abstract_id=1437408
Rosborough, L (2001) “Trends in foreign exchange trading”,
turnover”, Reserve Bank of New Zealand Bulletin, 68(3), pp.
16-26.
36
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
New Zealand’s imbalances in a cross-country context1
Daan Steenkamp
New Zealand’s current account deficit is the counterpart of a low rate of national saving relative to domestic investment.
Persistent current account deficits have led to the build-up of a large net international investment position (NIIP) financed
largely through foreign debt with short maturity. Dependence on foreign capital makes New Zealand vulnerable to
changes in the availability and cost of external financing, although New Zealand has not added to this vulnerability by
taking on currency risk. Debt maturity has lengthened over the recent past in response to market pressure and the Reserve
Bank’s Prudential Liquidity Policy. Apart from New Zealand’s financial vulnerability, high debt levels threaten to weigh on
economic growth by raising interest rates and crowding out private investment. A strong fiscal position in the run-up
to the global crisis served to allay concerns over New Zealand’s credit worthiness, but the government’s finances have
deteriorated in the wake of the crisis. It would therefore be prudent to improve the fiscal position sooner rather than
later. Faster fiscal consolidation would also contribute to the required rebalancing of the economy towards higher saving
and exports. This article considers New Zealand’s imbalances in a cross-country context in order to highlight sources of
vulnerability.
1
Introduction
increase in expenditure, not merely a cyclical reduction in
Over the past three decades, New Zealand has been running
revenue. A worsening fiscal position could have negative
one of the largest and most persistent current account
implications for borrowing costs and private sector access
deficits relative to other advanced economies. The deficit has
to capital. Faster fiscal consolidation would therefore be
largely been funded using foreign borrowing. As a result,
prudent. It would also contribute to the required rebalancing
New Zealand is one of the more indebted nations in the
of the economy.
OECD. The increase in New Zealand’s overseas debt largely
Domestic savings and investment behaviour are important
reflects private borrowing, much of which has been of short
features of New Zealand’s external imbalances. The current
maturity. This position makes New Zealand vulnerable to
account deficit is the counterpart of a gap between
changes in investor sentiment and credit ratings that raise
domestic saving and investment. While the investment
the cost of external financing or ultimately close off funding
rate is comparable to those of other OECD economies, the
altogether. Currency risk is, however, very low, since almost
saving rate is comparatively low. A higher investment rate
all foreign currency borrowing is hedged back to local
may reflect New Zealand’s growing population and desired
currency. The Reserve Bank can therefore provide local
catch-up to income per capita levels of other advanced
currency liquidity should funding risks spike unexpectedly.
economies. But low national saving implies a dependence on
New Zealand’s economy has been relatively resilient through
inflows of foreign capital. Over time, this foreign borrowing
the recent global financial crisis. This has reflected, in part,
requirement may weigh on growth by raising interest rates.
a comparatively low level of public debt. However, in the
New Zealand’s vulnerability to shocks can be reduced by
aftermath of the global crisis, the government’s finances have
gradual unwinding of its imbalances. Such rebalancing will
deteriorated. Much of the deterioration reflects a structural
likely require higher national saving, improved international
competitiveness and fiscal consolidation. The recovery that is
2
1
2
The author thanks Chris Bloor, Phil Briggs, Ashley
Dunstan, Norman Gemmell, Tim Hampton, David
Hargreaves, Bernard Hodgetts, Kirdan Lees, John
McDermott, Anella Munro, Ian Nield and Christie
Smith for comments and discussion.
Gross private overseas debt has risen from about
46 percent of GDP in 1989 to over 115 percent most
recently. The government’s gross overseas debt, on
the other hand, fell from 26 percent of GDP to below
10 percent prior to the global crisis.
currently under way displays some important features of the
required rebalancing, including higher household saving and
debt consolidation. Over the longer term, such a rebalancing
would enhance resilience and support higher and more
sustainable growth.
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
37
This article considers New Zealand’s imbalances in a cross-
Figure 1
country context in order to highlight sources of vulnerability.
Average current account balances for selected
Section 2 compares New Zealand’s external imbalances to
OECD economies
those faced by other advanced countries. A discussion of
(1980 - 2009)
8
internal imbalances is taken up in section 3, focusing on
6
household saving and investment behaviour and public
Percent of GDP
4
sector borrowing and creditworthiness. Section 4 considers
the rebalancing process and the adjustment that the New
2
0
-2
-4
Zealand economy must undergo. Section 5 concludes.
-6
2
Switzerland
Norway
Netherlands
Japan
Sweden
Germany
Finland
South Korea
Denmark
France
Italy
Canada
United Kingdom
Turkey
Mexico
Ireland
United States
Spain
Australia
Hungary
Poland
Iceland
New Zealand
Portugal
Greece
-8
New Zealand’s external
Source: IMF, Statistics NZ.
imbalance
Large and persistent current account deficits
The current account reflects the difference between
Build-up of foreign liabilities
domestic saving and total investment. In an open economy,
The flipside of the large current account deficit is a large
a part of domestic spending and investment can be financed
offshore financing requirement. Continuous current account
from capital inflows from other countries. For developed
deficits since 1973 have therefore led to a build-up of
economies, a current account deficit can be symptomatic
foreign liabilities (figure 2).3 The country’s NIIP, which reflects
of a lack of international competitiveness, leading to a trade
the balance of total assets held offshore and total liabilities
deficit and need to borrow to finance consumption in excess
owed to foreigners, has deteriorated to around 86 percent
of income.
of GDP – one of the highest levels among OECD countries
New Zealand’s large and persistent current account deficit,
however, reflects a low national saving rate relative to
domestic investment. The current account deficit has,
on average, largely been the product of a deficit on the
investment income account – the trade balance has been in
surplus for much of the last two decades. As such, the deficit
is strongly related to the country’s high stock of foreign
(figure 3). A high level of external liabilities increases a
country’s vulnerability. This is because creditors may become
increasingly anxious about the possibility that the country
will not be able to meet its debt service obligations, raising
Figure 2
Cumulative current account and NIIP (% of GDP)
-10
debt, low rates of return on foreign assets, and the relative
-30
Percent of GDP
attractiveness of New Zealand’s financial assets.
New Zealand’s current account deficit is large by OECD
standards. Figure 1 below plots New Zealand’s external
balances against those in other OECD countries. New
-50
-70
-90
NIIP
Zealand’s current account deficit averaged over 5 percent per
annum between 1980 and 2009 and over 8 percent in each
year between 2005 and 2008. Australia and New Zealand
have both been able to run large and persistent current
account deficits over several decades without experiencing a
sudden balance of payments reversal or a even a prolonged
rebalancing.
38
Cumulative current account
-110
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
Source: Statistics NZ, author’s calculations.
3
A country’s NIIP in a given period will equal the
current account deficit recorded in the previous
period plus the NIIP from the previous period,
adjusted for valuation changes. Valuation changes
occur because of changes in the exchange rates and
prices used to measure the values of the assets and
liabilities that comprise the NIIP.
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
Figure 3
Figure 5
NIIP for OECD countries in 2008
Sovereign credit default swap spreads for
(% of domestic GDP)
selected OECD countries*
-400
-300
-200
-100
0
100
200
Australia
New Zealand
Hungary
Ireland
Portugal
Poland
600
500
400
300
200
100
0
Jul-08
Nov-08
Mar-09
Jul-09
Nov-09
Mar-10
*
Credit default swaps measure the perceived riskiness
of debt denominated in a given national currency.
Source: Bloomberg.
Percent of GDP
Source: IMF, Statistics NZ, author’s calculations.
Figure 4
Despite the vulnerabilities associated with large external
Change in NIIP between 2000 and 2008
imbalances, New Zealand has been able to sustain a
(% of GDP)*
persistent current account deficit over recent decades.
Iceland
Portugal
Spain
Greece
Hungary
France
Poland
United States
Italy
New Zealand
Australia
United Kingdom
Switzerland
Sweden
Japan
Canada
Germany
Netherlands
Norway
-300
700
Basis Points
Switzerland
Norway
Japan
Germany
Netherlands
Canada
United Kingdom
Sweden
South Korea
France
Italy
United States
Turkey
Australia
Ireland
Greece
Spain
New Zealand
Portugal
Hungary
Iceland
One possible reason why markets have been so sanguine
about New Zealand’s deficit could be that the risk of a
sudden external adjustment has been quite low. A study by
Edwards (2006) suggests that, while a high deficit raises the
probability of an abrupt and costly external adjustment, the
risk of a large adjustment nevertheless remains relatively low
in New Zealand.4
-250
-200
-150
-100
-50
Percent of GDP
0
50
100
150
* A negative change reflects a deterioration in the NIIP.
Source: IMF, Statistics NZ, author’s calculations.
Financial market confidence about New Zealand’s ability
or willingness to repay its external obligations may also
reflect expectations of higher future incomes and economic
borrowing costs and making the repayment of debt even
more difficult. The recent experiences of Iceland, Greece,
Spain, Portugal and Hungary demonstrate the vulnerability
of countries with large net foreign liability positions (see
figure 4).
growth. If the deficit reflects investment in the economy,
inflows of foreign capital will raise the country’s capital stock
and growth potential.5 Provided that inflows are invested
productively, inflows may be expected to generate sufficient
additional income to service the country’s additional foreign
Burgeoning current account deficits and dependence on
obligations. Even though New Zealand’s growth performance
foreign capital have been a major source of fragility for
over recent decades has been lower than the OECD average,
several other economies in the OECD. Greece, Hungary,
research by the Treasury (Makin, Zhang and Scobie 2008)
Iceland, Ireland, Portugal and Poland have all seen the costs
suggests that the returns to foreign capital have been
of their external borrowing rise as global risk aversion spiked
sufficient to service the debts that have accompanied those
during the crisis and market perceptions of public sector
inflows.
credit worthiness (figure 5) subsequently deteriorated.
4
Factors that have distinguished New Zealand and Australia
include relatively strong fiscal positions prior to the crisis,
very low levels of currency exposure and floating exchange
rates.
5
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
For a given debt level and a current account deficit
of 3 percent, Edwards estimates that the probability
of a 5 percent of GDP adjustment in the current
account deficit is about 0.6 percent. Given a deficit of
9 percent of GDP, the probability rises to 5 percent.
See for example, Makin (2005), Kim, Hall and Buckle
(2006), or Munro and Sethi (2006).
39
Composition of New Zealand’s external
of total gross foreign debt, which is equivalent to around 80
balance sheet
percent of GDP. General government debt is a comparatively
The size and composition of the external balance sheet
small portion of external debt. Since bottoming at the end
has important implications for the transmission of external
of 2006 at 8.9 percent of GDP, gross public debt increased
shocks to its economy (Bedford 2008). The structure of the
to about 13 percent by the first quarter of 2010. On a net
external balance sheet will also have an important bearing
basis, public external debt stands at 6.7 percent of GDP and
on the evolution of the country’s external position. The gross
overseas bank debt is 64 percent of GDP (figure 7).
value of international assets and liabilities will be impacted
by movements in the exchange rate and domestic and
foreign asset prices.6 Changes in the returns to different
classes of foreign assets and liabilities will also impact cross-
Figure 6
New Zealand’s total gross external debt (% of
GDP)
160
border income flows.
Other sectors
Monetary authorities
General government
Banks
140
with a high average yield on New Zealand’s liabilities relative
to those on the country’s assets, have been responsible for
120
Percent of GDP
New Zealand’s large stock of net foreign liabilities, together
100
80
60
generating a large net deficit on the investment income
40
account. The deficit averaged over 6 percent to GDP
20
between 2000 and 2009. As mentioned earlier, a large
0
2000
deficit on the net international investment account has been
2001
2002
2003
2004
2005
2006
2007
2008
2009
Source: Statistics NZ, author’s calculations
a key contributor to the persistence of the current account
Figure 7
deficit.
New Zealand’s external deficit has been financed largely
New Zealand’s net external debt (% of GDP)
100
Other sectors
Monetary authorities
General government
Banks
through debt inflows. As a result, gross liabilities comprise
80
liabilities are in the form of borrowing, while debt comprises
60
over 90 percent of foreign liabilities on a net basis.
The vulnerabilities associated with foreign debt financing
will depend on the composition, maturity structure and
currency denomination of the stock of debt. New Zealand
has a large stock of external debt, much of which reflects
banking sector borrowing at relatively short maturities.
Percent of GDP
mostly debt. Over 80 percent of New Zealand’s gross foreign
40
20
0
-20
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Source: Statistics NZ, author’s calculations
Gross foreign debt to GDP peaked at over 130 percent in 2008
While New Zealand is relatively highly indebted on a net
(figure 6). Banks are responsible for more than 60 percent
basis, gross indebtedness is much lower compared to other
6
40
It appears that periods of strong nominal GDP growth
and favourable valuation changes have helped offset
some of the deterioration in New Zealand’s NIIP to
GDP ratio from cumulative current account deficits
(as in figure 2). Offsetting valuation changes are likely
to reflect the fact that New Zealand’s foreign assets
are slightly skewed to equity that have delivered
large valuation changes, while liabilities are skewed
to debt, almost all of which is denominated in local
currency or hedged. The latter implies that the
liabilities side of New Zealand’s balance sheet will be
less subject to revaluation effects from exchange rate
changes.
OECD economies. In the absence of comparable figures for
net external debt, cross-country debt figures are proxied
using gross stocks of portfolio debt and other investment
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
assets and liabilities (after subtracting financial derivates).7
revenues.8 This virtual absence of currency mismatch
On this basis, Figure 8 shows that New Zealand’s ratio of net
insulates domestic debtors against adverse exchange rate
foreign liabilities to GDP is higher than the median level for
fluctuations, reducing the impact of expectations of currency
the OECD, at over 70 percent of GDP in 2008. New Zealand’s
depreciation on debt and debt service costs.
gross position is, however, much lower in comparison to
other OECD economies (depicted as the blue bars in figure
8). This means that New Zealand has not used its foreign
borrowing to lend offshore.
Some refinancing risk
Reliance on short-term foreign borrowing makes a country
vulnerable to funding problems in the event of changes in
Figure 8
the availability of foreign lending. New Zealand does have
Gross and Net external debt in 2008 (% of GDP)
a reasonably high proportion of short-term debt to total
foreign borrowing, at about 40 percent (see figure 9). But
0
by OECD standards, New Zealand’s short-term foreign
-200
indebtedness does not appear to stand out. Available data
Percent of GDP
200
-400
suggest that the value of New Zealand’s outstanding short-
Net portfolio debt and other investment liabilities
-600
Gross portfolio debt and other investment liabilities
term debt securities are not high on a comparative basis,
Median gross obligations
-800
Median net obligations
both as a percentage of GDP or as a share of total gross
Iceland
Hungary
Portugal
New Zealand
Spain
Greece
Sweden
Australia
United States
Italy
Canada
Turkey
United Kingdom
France
South Korea
Norway
Netherlands
Japan
Germany
Ireland
Switzerland
-1000
Source: IMF, author’s calculations.
external debt in issue (figures 10 and 11).9 Both ratios have
also dropped in recent years relative to those in peer OECD
countries. Figure 12 shows that New Zealand’s foreign
exchange reserves cover a relatively large portion of the
country’s short-term external debt, even though the gross
Low currency risk
level of foreign reserves remains reasonably low relative to
Debt funding implies exposure to changes in interest rates
some other OECD countries.
and roll-over risk as loans mature. Compared to other
Figure 9
countries, currency risk is low in New Zealand. About half
Maturity composition of foreign liabilities
160
currency. Almost all of New Zealand’s foreign currency debt
140
(93 percent) is hedged, either using financial derivative
120
Percent of GDP
of New Zealand’s gross foreign debt is denominated in local
contracts or by matching foreign currency exposures
with foreign currency assets or expected foreign currency
<1 year
1 to 5 years
> 5 years
Unspecified
100
80
60
40
7
Figure 8 uses a balance of payments presentation to
compare New Zealand’s external position to other
countries. This approach nets out cross-border
inter-company borrowing and lending and excludes
financial derivatives. Note that the foreign debt
figures presented in figures 6 and 7, on the other
hand, are based on a balance sheet approach. In the
balance sheet presentation of the external position,
all forms of lending are classified as assets and all
forms of borrowing are classified as liabilities. The
balance sheet and balance of payments presentations
provide the same NIIP, equity positions and reserve
asset balances. But gross estimates of the foreign
debt will differ depending on the composition of
individual assets and liabilities. See Statistics New
Zealand’s ‘Balance of Payments and International
Investment Position’ reports, available from their
website, for more detail.
20
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Source: Statistics New Zealand
8
9
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
See Statistics New Zealand’s annual hedging survey.
Results are available in their ‘Balance of Payments
and International Investment Position’ reports
published on their website.
External debt should be calculated as borrowing
to non-residents less financial derivatives. Because
a breakdown of financial derivatives by maturity is
not published, New Zealand’s short-term external
debt is proxied using short-term external borrowing
only, whereas gross external debt is total external
borrowing less total financial derivatives. New
Zealand’s short-term debt figures will therefore be
slightly overstated in figures 10-14.
41
Figure 10
The banking sector remains exposed to liquidity and
Short-term external debt (by maturity) as a
refinancing risk should domestic conditions deteriorate
proportion of total gross external debt
or external events cause global interest rates to spike
(June 2008)
or liquidity to dry up. Over 40 percent of New Zealand’s
domestic bank lending is funded via offshore borrowing and
United Kingdom
Switzerland
Japan
Norway
New Zealand
Sweden
Netherlands
France
South Korea
United States
Ireland
Portugal
Germany
Canada
Italy
Australia
Spain
Greece
Poland
Turkey
Hungary
over 50 percent of this is short term. Domestic on-lending
by banks is, however, focused on longer-term advances such
as mortgage loans. Housing debt owed to registered banks
totals over 90 percent of household lending from banks.
Several factors offset these risks. New Zealand banks’
hedging activities largely reduce interest rate risk. Banks
0
20
40
Percent
60
80
Source:World Bank, Statistics New Zealand, author’s
calculations.
have tended to reduce funding costs by borrowing in foreign
currency in foreign wholesale markets and then using swap
contracts to convert the proceeds into New Zealand dollars.
This transforms foreign short-term borrowing into local
Figure 11
currency borrowing that is only subject to longer term re-
Short-term external debt (by maturity) as a
pricing.10 Government guarantees and the Reserve Bank’s
proportion of total gross external debt
liquidity operations also played a key role in maintaining
(June 2010)
the supply of funding during the crisis. The introduction
United Kingdom
Japan
Switzerland
Greece
Norway
Portugal
New Zealand
Ireland
France
Netherlands
South Korea
United States
Germany
Sweden
Canada
Spain
Australia
Italy
Turkey
Poland
Hungary
of the Crown wholesale guarantee scheme in November
2008 buttressed confidence in the market for New Zealand
debt and helped secure bank sector funding.11 The lack of
currency exposure on external debt means that the Reserve
Bank can provide New Zealand dollar liquidity should local
borrowers face stress in external funding markets. Access to
external financing is also supported by the linkages between
0
20
40
Percent
60
80
Source:World Bank, Statistics New Zealand, author’s
calculations.
Australian parents and domestic banks.
In response to market pressures, domestic banks have
Figure 12
refinancing risk. The Reserve Bank’s Prudential Liquidity
Total foreign reserves to short-term external
Policy also underpinned this development, by requiring a
debt
larger proportion of long-term wholesale financing and retail
(December 2009)
deposits.12 Bank funding with a maturity of more than 1 year
Foreign reserves less gold to short-term
external debt (Percent)
lengthened the maturity of funding to reduce their
has increased from about 34 percent of total in mid-2008
200
180
to 44 percent.
160
140
120
100
80
60
12
10
40
11
20
Source: IMF, BIS, Statistics NZ, author’s calculations.
42
South Korea
Chile
Hungary
Japan
Turkey
Norway
Canada
New Zealand
Sweden
Australia
Italy
Switzerland
Finland
Spain
Germany
France
United States
Portugal
Netherlands
United Kingdom
Ireland
Greece
0
See Craigie and Munro (2010) for more detail.
See Financial Stability Report November 2010.
At the time of writing, domestic banks’ core funding
levels exceed the current minimum ratio (65 percent)
as well as the level that the ratio is expected to be
raised to over the next two years (75 percent).
Banks’ liquid asset positions also remain well above
the minimum required level.
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
Government guarantees and liquidity operations can
Figure 14
transfer some private credit risk to the public sector. Banking
Gross national saving (average 2000 to 2007 %
sector stresses and interbank freezes can feed through
of GDP)
to sovereign liquidity and solvency risk.
13
The recent Irish
40
35
experience offers an important warning about the potential
30
Percent of GDP
impact of government bank bailouts on the solvency of the
25
20
public sector.
15
10
5
New Zealand’s external imbalances are inextricably linked
Norway
Switzerland
Netherlands
South Korea
Japan
Finland
Sweden
Mexico
Denmark
Ireland
Canada
Chile
Spain
Australia
Italy
Germany
France
New Zealand
United States
Low national saving rate
United Kingdom
Iceland
Greece
Domestic imbalances
Portugal
0
3
Median
Source: OECD.
to domestic imbalances. A low national saving rate relative
to investment manifests as a large and persistent current
A low saving rate has important implications for macro-
account deficit. Higher levels of public and private debt
stability and future growth prospects.14 Low national saving
make the economy vulnerable to shocks and weigh on
implies a dependence on inflows of foreign capital, which
New Zealand’s growth potential by raising interest rates and
over time increases debt service costs. Servicing the foreign
crowding out private investment. It also reduces the scope
borrowing requirement may weigh on the performance of
for counter-cyclical fiscal responses to shocks.
the economy if higher levels of debt lead to higher interest
The national saving rate has fallen slightly over recent years,
while the investment rate has remained largely stable. The
decline in national saving has seen a widening in the gap
rates and lower capital accumulation. Figures 15 to 16
compare interest rates in OECD countries and demonstrate
that New Zealand’s interest rates have been relatively high.
between New Zealand’s saving and investment rates. While
Figure 15
the investment rate has been just above the median for
Comparative real short-term interest rates* and
OECD countries (figure 13), New Zealand’s saving rate has
NIIP
been low by OECD standards (figure 14).
Figure 13
Gross Fixed Capital Formation (average 2000 to
2007 % of GDP)
40
35
Percent of GDP
30
25
20
Real short-term interest rates
(Percent, Per annum) average 2000 to 2009
5
15
ICE
4
NZ
MEX
3
HUN GRE
UK
NOR
AU
2
KOR
1
SWE
CAN
US
SWISS
JAP
0
-400
-300
-200
-100
0
100
200
NIIP (percent of GDP) in 2008
10
5
Spain
South Korea
Iceland
Australia
Japan
Ireland
Greece
New Zealand
Italy
Switzerland
Portugal
Mexico
Canada
Chile
Denmark
Netherlands
France
Finland
Norway
United States
Sweden
Germany
United Kingdom
0
* Annual average nominal interest rates less average annual
consumer prices.
Source: OECD, IMF, author’s calculations.
Median
Source: IMF.
13
By
impairing
Government’s
perceived
creditworthiness, a banking crisis could set off a
sudden stop in capital inflows. See André (2010)
for a description of plausible scenarios of a sudden
adjustment, in the context of recent international
experiences.
14
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
See New Zealand Treasury (2010) for a detailed
discussion.
43
Figure 16
Low household saving
Comparative real long-term interest rates* and
Official data suggest that households in New Zealand have
NIIP
been dis-saving, in effect financing consumption out of
accumulated saving, borrowing or increases in wealth from
Real long-term interest rates
(Percent, Per annum) average 2000 to 2009
5
3
rising asset prices. Households displayed a high propensity to
MEX
4
finance consumption using debt in pre-crisis years – reacting
NZ
SWE
NOR
UK
AU KOR
AUST
GER
FRA
CAN BEL
ITA
POR
NETH
US
IRE
HUN GRE
JAP
SPA
ICE
2
to strong growth in house prices by withdrawing housing
equity.16 The household saving rate has trended down since
SWISS
1989 and has been negative for much of the recent decade
1
0
-400
(figures 17 and 18).
-300
-200
-100
0
NIIP (percent of GDP) in 2008
100
200
* Annual average nominal interest rates less average annual
consumer prices.
Source: OECD, IMF, author’s calculations.
Figure 17
Gross saving by sector
20
15
associated with New Zealand’s external debt. Monetary
policy may also increase interest rates in response to the
10
Percent of GDP
Higher interest rates could reflect higher risk premia
5
0
inflationary consequences of low saving and debt-financed
-5
consumption.15 The latter explanation for high interest rates
National
General government
Households
Business (residual)
-10
in New Zealand appears to be particularly applicable in
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
the decade preceding the crisis, as it was characterised by
Source: Statistics New Zealand
abundant global liquidity and compression of country risk
Figure 18
premia.
Saving rate by households in New Zealand
5
Prior to the global crisis, relatively high interest rates also
currency. A strong currency has tended to reinforce the
current account deficit by lowering returns to exports and
lowering the cost of imported goods. Over time, this has
produced a divergence between the fortunes of the traded
3
Percent of disposable income
tended to attract yield-seeking inflows, strengthening the
1
-1
-3
-5
-7
-9
Net
Gross
-11
-13
and non-traded sectors in New Zealand, creating considerable
demand for imports and reducing the economy’s capacity to
2009
-15
1992
1994
1996
1998
2000
2002
2004
2006
2008
expand exports and unwind the imbalances.
Source: Statistics New Zealand
Erratum: This online version uses the corrected figure.
The economy could be burdened with substantially higher
There
debt service costs should global investors increase the rates
household sector income and balance sheet estimates in
of return they require for lending to New Zealand residents.
New Zealand.17 These measurement issues makes accurate
In the aftermath of the global financial crisis and stress in
16
the sovereign debt markets elsewhere, global credit markets
remain cautious about markets and sovereigns that appear
risky.
15
44
See Labuschagne and Vowles (2010).
17
are
measurement
problems
associated
with
See Briggs (2008).
A full set of institutional sector accounts is not
currently produced in New Zealand. There is
likely to be substantial under-coverage of the crossholdings of assets and income sharing between
households and businesses in New Zealand in the
existing estimates. Several papers have highlighted
problems with different measures of saving in New
Zealand (see for example Claus and Scobie (2002),
Bascand, Cope and Ramsay (2006) or Scobie and
Henderson (2009). .
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
comparison of New Zealand’s household saving rate with
during the run-up to the global crisis, as rapidly growing
other countries difficult.18 Nevertheless, the official figures
credit inflated asset price booms that facilitated even more
are the best estimates of the economy’s historical saving
credit extension. Rising housing equity collateralised growth
performance and suggest that New Zealand has the lowest
in credit extension and higher levels of debt, weighing on
household saving rate in the OECD (figure 19), albeit with
disposable income despite lower interest rates. There is
the aforementioned caveat.
evidence that New Zealand’s strong consumption pre-crisis
19
was related to a rise in household wealth.21
Figure 19
Net household saving by selected OECD
countries (2009)
Households are exposed to property prices
Percent of disposable household
income
18
A significant portion of New Zealand households’ wealth
16
is stored in the form of housing.22 The concentration of
14
12
household wealth in property has meant that wealth is
10
8
dependent on trends in property prices. New Zealand house
6
prices grew very rapidly prior to the global crisis (figure 20).
4
2
This contributed to a considerable increase in household
Switzerland
Sweden
Belgium
Austria
Germany
Netherlands
Italy
Ireland
Poland
Norway
Canada
Australia
Slovak Republic
United States
Korea
Hungary
Finland
Denmark
Japan
Czech Republic
0
Source: OECD
The current account deficit and low national saving need
to be viewed against a global backdrop of historically low
global long-term real interest rates. Prior to the crisis, easing
net wealth between 2001 and 2006, in turn enabling debt
accumulation via stronger household balance sheets.
Figure 20
Nominal House Prices in selected economies
160
2000 to pre-crisis peak
140
Pre-crisis peak to trough*
120
encouraged debt accumulation and discouraged saving in
countries with open financial markets.20 For example, in the
US, Canada, UK and Australia, self-reinforcing cycles of credit
100
Percent change
borrowing constraints, associated with abundant liquidity,
80
60
40
20
0
growth, asset price growth and rising indebtedness emerged
-20
-40
18
19
20
The paucity of data also prevents accurate analysis of
whether the deterioration in household saving in the
country prior to the crisis reflected a partial offset
to rising government saving pre-crisis or ‘piercing of
the corporate veil’ via offsetting changes in business
saving. This problem can be addressed by analysing
the saving behaviour of the private sector as a
whole. On this basis, business saving (measured as
a residual) has remained relatively stable, averaging
14 percent between 2000 and 2009.
Note that household saving rates may not be
directly comparable. Reasons include, for example,
the calculation of depreciation in estimating
net saving from the gross figures, the treatment
of unincorporated businesses and non-profit
organisations in the national accounts or whether
pension benefits and contributions are included in
disposable income.
This owed, in part, to structural surpluses in oil
producers and fast-growing Asian economies, as well
as reserve accumulation by developing countries
seeking to amass the resources required to intervene
in foreign exchange markets and self-insure against
‘sudden stops’ in the availability of foreign capital.
United
States
United
Kingdom
Australia
New
Zealand
Ireland
Spain
* At the time of writing, available data suggest that prices
have not yet reached a trough in Spain, Ireland, the
UK or the US.
Source: BIS, author’s calculations.
New Zealand households’ debt-to-income ratio rose rapidly
prior to the global crisis, tripling since the early 1990s.
Though very high by New Zealand’s own historic standards,
this ratio is not dramatically higher than in OECD economies
with liberalised financial markets (Figure 21). In the run-up to
the crisis, credit growth was however lower in New Zealand
21
22
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
See De Veirman and Dunstan (2008) and (2010).
See New Zealand Treasury (2010) or Le, Gibson and
Stillman (2010).
45
than in countries where the subsequent housing corrections
History suggests that debt ratios may be set to decline
have been particularly pronounced, such as Ireland and
further in the coming years, particularly in economies that
Spain (see figure 22).
experienced banking crises. A recent Bank of International
Settlements paper suggests that, on average, private sector
Figure 21
Household debt as a proportion of disposable
income for selected countries
financial crisis.23
Homeowners in New Zealand appear to have an adequate
200
180
Percent of disposable income
debt to GDP tends to fall by 38 percent in the wake of
160
New Zealand
Canada
France
United Kingdom
United States
Australia
buffer to absorb adverse shocks. Debt service costs rose
in the run-up to the financial crisis as policy tightened,
140
but subsequently declined as the policy rate was lowered
120
and effective interest rates fell. At present, the ratio of
100
non-performing loans remains relatively low (see Financial
80
Stability Report November 2010). Moreover, the bulk of
60
mortgage debt is held by higher-income households, who
40
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
are more able to service their debt stocks.24
Source: OECD, RBNZ, RBA.
Households’ debt service capacity nevertheless remains
Figure 22
vulnerable to shocks to income or interest rates. Any severe
Credit growth and house prices in selected OECD
or persistent housing correction or tightening of lending
countries
conditions would also significantly drag on GDP growth as
the deterioration of household balance sheets feeds through
Change in private credit to GDP ratio
(2000 to 2008) Percent
140
120
to confidence and consumption. By impacting the perceived
IRE
100
SPA
80
DEN
credit worthiness of domestic banks and the government,
weakening domestic fundamentals could lead to a larger
60
UK
NETH
NOR
40
NZ
premium for offshore funding. In this way, a reliance of
AU
ITAL
CAN
FRA
20
US
SWISS
foreign borrowing could amplify the impact of household
sector stresses on the economy.
0
GER
-20
-20
0
20
40
60
80
Cumulative change in real house prices (2000 to 2008) Percent
Source: OECD, IMF.
A strong initial fiscal position an important
The rebalancing has involved weaker credit growth as banks
risk offset
have faced stressed credit markets and weaker demand for
While household saving fell significantly in the years prior
credit as households and businesses have focused on repaying
to the crisis, government saving offset some of that decline.
debt and reducing leverage. House prices have also declined
On a gross basis, government saving averaged over 5
in tandem with the reduction in credit and weak sentiment.
percent of GDP between 1994 and 2009, with a return to
House prices in New Zealand fell by over 10 percent from
consistent budget surplus from the mid-1990s. This allowed
their peak to their trough, but the adjustment has been
government to repay debt, which fell to below 30 percent
modest compared to some other OECD countries. Tighter
of GDP at end 2006 on a gross basis. A low level of public
credit conditions have placed further downward pressure on
debt and government surpluses in the run-up to the crisis
house prices, which has tended to raise effective leverage,
meant that the Government had the fiscal space necessary
as witnessed by the slight rise in the debt-to-housing -value
to support the economy via expansive fiscal policy during
ratio in New Zealand over the last year.
the downturn. New Zealand’s government debt remains low
relative to other OECD economies (figure 23).
23
46
See Tang and Upper (2010).
24
See Kida (2009).
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
Figure 23
fiscal strategy, show that consolidating public finances will
Comparative stocks of government liabilities in
take several years. Net public debt is projected to reach
2009
over 26 percent of GDP by 2014, from 5.8 percent in 2008.
Reducing net debt to the Treasury’s target of 20 percent of
Japan
Italy
Iceland
Greece
Portugal
France
Hungary
United States
Canada
Germany
United Kingdom
Ireland
Netherlands
Spain
Poland
Sweden
Norway
Switzerland
New Zealand
South Korea
Australia
GDP is projected to take until 2022.
Financial markets and ratings agencies are continually
General government gross
financial liabilities
General government net
financial liabilities
reassessing country-specific credit risk, particularly for
countries seeking to finance this borrowing externally.
Although New Zealand’s sovereign debt remains relatively
low, the country’s overall capacity to absorb future shocks
-180
-130
-80
-30
20
Percent of GDP
70
120
170
220
through additional borrowing will be constrained as public
debt rises.
Source: OECD
The government’s finances are also vulnerable to changes in
But the strong fiscal position has reversed
the availability of foreign capital or, at least, higher costs of
In the aftermath of the crisis, the borrowing needs of most
external financing. In the context of impaired credit markets,
advanced economies have expanded rapidly. This is due
higher public borrowing requirements are also more likely
to both the costs of fiscal stimulus, support for troubled
to crowd out more productive investment by competing
institutions, as well as automatic stabilisers – expanding
with private borrowers for available funding. Crowding out
welfare payments and lower tax receipts brought on by
could become more severe once the economy has recovered
the recession that the crisis produced. The reversal in
and growth is closer to its potential. Fiscal consolidation is,
New Zealand’s fiscal position since the recession has been
therefore, important for reducing pressure on interest rates
significant by OECD standards (figure 24).
and, therefore, the exchange rate, as well as for restoring
the economy’s buffers against shocks.
Figure 24
General Government cyclically-adjusted budget
balances
4
6
Average 2000 to 2008
4
Percent of GDP
A smooth rebalancing is required to maintain macroeconomic
2009
2
The required rebalancing
and financial stability in New Zealand.25 There are four ways
2011
0
-2
to stabilise and gradually reduce New Zealand’s ratio of net
-4
foreign liabilities to GDP. These include erosion of the real
-6
-8
debt burden through higher inflation, a reduction in imports,
-10
-12
United States
Switzerland
United Kingdom
Spain
Sweden
Poland
Portugal
Norway
Netherlands
New Zealand
Italy
Japan
Iceland
Ireland
Greece
Hungary
France
Germany
Finland
Canada
Denmark
Australia
-14
Source: OECD
higher exports or an improvement in the country’s growth
performance. The first option – greater tolerance for inflation
– would likely be costly and ineffective, since New Zealand’s
debt is largely short-term and rising inflation expectations
would therefore quickly translate into higher interest rates
The change in the cyclically adjusted budget balance
on existing and future issuances. The first option is also ruled
between 2007 and 2009 was the third largest in the OECD,
out by the Reserve Bank’s inflation-targeting mandate and
behind Spain and Ireland. Much of the deterioration in New
the Bank’s independence from Government.
Zealand’s fiscal position owes to rising spending and lower
tax rates, rather than a cyclical falloff in revenue from weaker
growth. Treasury forecasts, based on Government’s current
Rebalancing the economy towards the tradeables sector
would be supported by rebalancing of the global economy
25
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
See Bollard (2005).
47
and a more competitive currency. Global imbalances reflect
rate normalisation is unlikely over the short term, so that
recurrent current account deficits in several major industrial
New Zealand financial assets are likely to remain attractive
countries and current account surpluses in a number of Asian
to yield-seeking investors.
economies and oil exporters. A gradual global adjustment is
likely to require higher saving and exports in countries with
current account deficits and domestic demand-led growth
5
and currency appreciation in surplus economies.
New Zealand has, over the last several decades, run large and
There are indications of some unwinding of global imbalances
in the wake of the global crisis. While some of this is a cyclical
adjustment to lower trade growth, there is evidence that
a large part of the reduction in global imbalances reflects
a rebalancing of import and export growth (Freund 2010).
This would tend to be more sustainable once global trade
Conclusion
persistent current account deficits. As a result, New Zealand
is one of the most indebted nations in the OECD on the
basis of its net international investment position. The postcrisis world is characterised by cautious markets, studying
data for signs of fundamental weakness and indications of
adverse future debt dynamics.
recovers because it is a manifestation of shifts in domestic
New Zealand’s high stock of foreign debt means that the
saving and investment. Longer-term global rebalancing will
country remains vulnerable to changes in the availability and
require that these trends become entrenched as the recovery
cost of external financing. The country’s banking institutions
in the global economy takes deeper root.
are exposed to refinancing risk because of their dependence
There are also signs of internal rebalancing. Households in
New Zealand and in many countries have made efforts to
increase saving and reduce indebtedness. In the short term,
lower consumption and credit growth is weighing on growth.
While these shifts represent a natural cyclical adjustment to
the past recession, it is important that they develop into a
on short-term, foreign wholesale funding. Bank balance
sheets are also exposed to shocks to households’ debt
service capacity, such as higher borrowing costs, declines in
house prices or income. Over time, a dependence on inflows
of foreign capital may weigh on growth by raising interest
rates.
structural change in behaviour. This will support the long-
Several factors, however, mitigate these risks. Foreign
run sustainability of domestic and global growth paths.
exchange risk is very low since New Zealand’s foreign liabilities
The increase in household saving has, however, been offset by
the reduction in public saving. While fiscal policy is providing
an important buffer at present, fiscal retrenchment over the
longer term will be necessary to ensure that national saving
rises in future and that government regains the flexibility
to respond to any unexpected future shocks. Improved
are largely denominated in local currency or hedged. As a
result, the Reserve Bank can supply local currency liquidity
should credit conditions deteriorate. The maturity structure
of bank funding has lengthened owing to market pressure
and the implementation of the Reserve Bank’s Prudential
Liquidity Policy, moderating roll-over risk.
Government saving will also be crucial in preparing for
The shift from debt-financed consumption to greater saving
increased spending pressures associated with the ageing
and investment is also expected to support the household
population.
sector’s capacity to repay its debt. Continued rebalancing is
Given the drag on growth from internal rebalancing and
withdrawal of fiscal stimulus over the medium term, an
external rebalancing via stronger tradeables growth would
desirable, but will face headwinds in the form of a strong
currency, weak foreign demand and low global interest
rates.
significantly reduce the risk of an abrupt and disorderly
While a relatively favourable fiscal position differentiated
rebalancing. Global factors are, however, expected to
New Zealand from most other OECD governments prior to
continue supporting the New Zealand dollar. Global interest
the crisis, the deterioration of the fiscal balance reduces the
48
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
economy’s capacity to respond flexibly to shocks. Faster fiscal
Hoekman (eds.) Rebalancing the Global Economy: A Primer
consolidation would be a prudent approach to sustaining
for Policymaking, VoxEU.org publication, 23 June.
the required rebalancing over the long term.
Goh, K (2005) “Savings and the household balance sheet”,
Reserve Bank of New Zealand Bulletin, 68 (2)
References
André, J (2010) “Economic imbalances: New Zealand’s
structural challenge”, New Zealand Treasury Working Paper.
Forthcoming.
Bedford, P (2008) “The global financial crisis and its
transmission to New Zealand - an external balance sheet
analysis”, Reserve Bank of New Zealand Bulletin, 71 (4).
Bollard, A (2005) “Imbalances in the New Zealand economy”,
Reserve Bank of New Zealand Bulletin, 68 (4).
Kim, K, V B Hall and R A Buckle (2006) “Consumption
smoothing in a small, cyclically volatile open economy:
evidence from New Zealand”, Journal of International
Money and Finance, Vol.25(8), pp.1277-1295
Hoskin, K, I Nield and J Richardson (2009). “The Reserve
Bank’s new liquidity policy for banks,” Reserve Bank of New
Zealand Bulletin, 72 (4).
Kida, M (2009) “Financial vulnerability of mortgage-indebted
households in New Zealand - evidence from the Household
Economic Survey”, Reserve Bank of New Zealand Bulletin,
Briggs, P (2008) “Inheritances and their impact on housing
72 (1).
equity withdrawal”, Reserve Bank of New Zealand Discussion
Paper, DP2008/16.
Labuschagne, N and P Vowles (2010) “Why are real interest
rates in New Zealand so high? Evidence and drivers”, New
Claus, I and G Scobie (2002) “Saving in New Zealand:
Zealand Treasury Working Paper. WP10/09
measurement and trends”, Treasury Working Paper, 02/02.
Le, T, J Gibson and S Stillman (2010) “Household wealth
Cook, B and F Delbrück (2010) “The crisis and the Reserve
Bank’s stabilisation role”, Reserve Bank of New Zealand
Bulletin, 73 (3).
Craigie, R and A Munro (2010) “Financial sector amplification
and credit cycles in New Zealand”, Reserve Bank of New
Zealand Bulletin, 73 (2).
De Veirman, E and A Dunstan (2008) “How do housing
wealth, financial wealth and consumption interact?
Evidence from New Zealand”, Reserve Bank of New Zealand
and saving in New Zealand: Evidence from the Longitudinal
Survey of Family, Income and Employment”, Working Papers
10/06, Motu Economic and Public Policy Research.
Makin, A, W Zhang and G Scobie (2008) “The contribution
of foreign borrowing to the New Zealand economy”, New
Zealand Treasury Working Paper Series 08/03.
Munro, A and R Sethi (2007) “Understanding the New
Zealand current account: a structural approach”, Reserve
Bank of New Zealand Discussion Paper, DP2007/10.
Discussion Paper, DP2008/05.
Reserve Bank of New Zealand (2010) Financial Stability
De Veirman, E and A Dunstan (2010) “Debt dynamics
Report, November.
and excess sensitivity of consumption to transitory wealth
changes,” Reserve Bank of New Zealand Discussion Paper,
DP2010/09.
G Scobie and K Henderson (2009), “Saving rates of New
Zealanders: a net wealth approach”, New Zealand Treasury
Working Paper Series 09/04.
Edwards, S (2006). “External imbalances in an advanced,
commodity-exporting country: the case of New Zealand,”
NBER Working Papers 12620, National Bureau of Economic
Research, Inc.
Freund, C (2010) “Adjustment in global imbalances and the
Tang, G and C Upper (2010) “Debt reduction after crises”,
BIS Quarterly Review, September 2010.
New Zealand Treasury (2010) “Saving in New Zealand - Issues
and options”, available: http://purl.oclc.org/nzt/p-1322
future of trade growth”, in S Claessens, S Evenett and B
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
49
DISCUSSION PAPERS
DP2010/06
be a weighted arithmetic average. The analysis covers both
Sharing a risky cake
finite and infinite time.
David Baqaee and Richard Watt
Consider an n-person bargaining problem where players
bargain over the division of a cake whose size is stochastic.
In such a game, the players are not only bargaining over
the division of a cake, but they are also sharing risk. This
DP2010/09
Debt dynamics and excess sensitivity of
consumption to transitory wealth changes
paper presents the Nash bargaining solution to this problem,
Emmanuel De Veirman and Ashley Dunstan
investigates its properties, and highlights a few special
We analyse the consumption-wealth relationship using a
cases.
framework that accounts for transitory variation in wealth,
and in a setting where transitory variation in household net
worth is not dominated by boom and bust cycles in stock
DP2010/07
markets. We find that transitory variation in consumption
Exporting and performance: market entry,
depends positively on recent transitory changes in wealth. In
expansion and destination characteristics
addition, we find that gross asset wealth and household debt
Richard Fabling and Lynda Sanderson
are positively related. Both findings constitute departures
We examine the effect of export market entry on New
from standard lifecycle/permanent income hypothesis theory
Zealand firm performance. Our novel contribution to the
with complete financial markets, but can be explained by
literature is the treatment of export status as an incremental
the introduction of liquidity constraints.
process, in which firms may export to one or more markets
with each of these markets providing additional potential for
learning to occur. Focussing on new markets provides several
benefits. Since we use matching techniques to account for
self-selection, controlling for firm export histories reduces the
DP2010/10
Does the Kiwi fly when the Kangaroo jumps?
The effect of Australian macroeconomic news
problem of selection on unobservables (such as managerial
on the New Zealand dollar
preferences) which would confound a causal interpretation.
Andrew Coleman and Özer Karagedikli
Also, most new market entry is undertaken by incumbent
We conduct an event study that examines how the New
exporters, providing a large number of events on which to
Zealand - US (NZ/US) and the Australia - US (AU/US) exchange
test the learning-by-exporting (LBE) hypothesis.
rates responds to the release of Australian macroeconomic
news including the CPI, GDP, trade balance, and monetary
policy decisions. We use two different measures of the
DP2010/08
unanticipated component of the news announcements. First,
Intertemporal choice: a Nash bargaining
we use the difference between the actual value of the data
approach
and a survey of market participants’ expectations of that data
David Baqaee
announcement. Second, we use the immediate response of
A compelling, but highly tractable, axiomatic foundation for
the AU/US exchange rate to the news announcement.
intertemporal decision making is established and discussed.
Our study has three main conclusions: 1) We show that
This axiomatic foundation relies on methods employed in
the effects of the macro news in one country can also
cooperative bargaining theory. Four simple axioms imply that
transmit to another country via the non-bilateral exchange
the intertemporal objective function is a weighted geometric
rate (probably in anticipation of future spill-over effects). 2)
average of each period’s utility function. This is in contrast
Combined with results that show that the AU/US exchange
to standard practice, which takes the objective function to
rate responds by very little to New Zealand news, the results
50
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
suggest that the low variation in the New Zealand - Australia
cross rate is because both currencies respond in a similar
fashion to Australian (but not New Zealand) macroeconomic
data. 3) We highlight the problems associated with the
events studies in which the surprises are calculated from a
market price and propose a new estimator that overcomes
this problem.
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
51
NEWS RELEASES
Reserve Bank Bulletin released
banks as well as retail deposits by eligible depositors in non-
30 September 2010
bank deposit-taking entities, including building societies,
The Reserve Bank today released the September 2010 issue
credit unions and finance companies.
of the Reserve Bank of New Zealand Bulletin.
Dr Bollard described the retail deposit guarantee scheme as
Our lead article shows how yield curves can help economists
a temporary measure designed to give assurance to New
understand such events as the global financial crisis. The
Zealand depositors, while continuing to ensure the efficient
yield curve describes the relationship between interest rates
functioning of New Zealand financial markets.
and debts with different maturities, for example the differing
The scheme was successful on both counts, he said. “It is
returns on one, two- and five-year mortgages. The article
now time to put banks and non-bank deposit takers, such as
discusses yield curves for government debt, bank securities
building societies, credit unions and deposit-taking finance
and mortgage rates.
companies, on a normal footing.
Our second article looks at the New Zealand dollar and the
“The scheme was set up in response to exceptional
impact of the global financial crisis on our currency. The
circumstances, at a time of international financial market
article identifies three key drivers of the exchange rate:
turbulence. That crisis is now well past us.”
interest rate differentials, commodity prices and investors’
risk appetite.
The Reserve Bank’s focus with the retail deposit scheme
was on the stability of New Zealand’s financial sector. From
The Reserve Bank has responsibilities under the new Anti-
1 December 2010, the Reserve Bank will oversee new
Money Laundering and Countering Financing of Terrorism
regulations governing non-bank deposit takers.
Act from 2009. Our third article explains the regulatory and
supervisory risk-based framework established by this Act
and describes the Reserve Bank’s supervisory approach.
Our final article describes the Reserve Bank’s approach to
managing the currency composition of its reserves portfolio.
When reserves are fully hedged, foreign currency assets are
Dr Bollard said banks now enjoy a strong level of public and
market confidence.
He said parts of the non-bank lending sector had come
through the recent period well. Other parts would continue
to face adjustment.
matched with foreign currency liabilities, leaving little net
“In the finance company sector, over the medium term,
foreign exchange rate risk. In July 2007, the Reserve Bank
there’s an improving outlook most notably for institutions
moved away from a fully-hedged reserve position, which
with stronger capital positions and better risk and liquidity
made the currency composition of reserves a key decision.
management practices.
“Among savings institutions, comprising building societies,
credit unions and the PSIS, there will likely remain a high
Retail deposit guarantee scheme
level of confidence, supported by their sound performance
8 October 2010
through the recent downturn.
The Reserve Bank says the current Retail Deposit Guarantee
Scheme, which ends on 12 October 2010, has served its
purpose. Depositors will now need to take full account of
the risks, returns and credit ratings associated with their
“In the absence of a government guarantee, it is vital that
depositors understand the risks and the potential trade-off
between risk and return. In this regard, one useful tool is an
entity’s credit rating – which banks and all but the smallest
deposits, Governor Alan Bollard said today.
NBDTs are required to hold and publicly disclose.
The deposit guarantee scheme (which has been extended
for a limited number of companies on tighter terms), is
administered by the New Zealand Treasury and has covered
all retail deposits of participating New Zealand-registered
52
“The more stringent regulatory regime for deposit-taking
institutions will be a further catalyst for change.”
The Reserve Bank is the prudential regulator of non-bank
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
deposit takers which, from 1 December 2010, will be
commence on 1 December 2010. These regulations
required to have:
require quantitative liquidity requirements to be included
in trust deeds.
• Credit ratings from an approved rating agency.
• Governance arrangements designed to ensure they give
proper consideration to the interests of all stakeholders.
The Bank will shortly release guidelines on quantitative
liquidity requirements. “These guidelines are intended
to assist NBDTs and trustees to meet prudential liquidity
• Risk management programmes outlining how they
requirements,” Mr Spencer said.
will identify and manage key risks, such as credit and
liquidity risk.
The consultation paper and information on prudential
liquidity requirements can be accessed on the Bank’s website
• Minimum capital requirements included in trust deeds.
(http://www.rbnz.govt.nz/finstab/nbdt/index.html).
• Restrictions on a deposit taker’s related party exposure.
• Liquidity provisions enabling them to withstand a
plausible range of shocks.
Reserve Bank and NZX reach agreement
11 October 2010
The Reserve Bank and NZX today announced an agreement
Developments in the non-bank deposit-taking
sector
on the provision of clearing and settlement services to New
Zealand’s capital markets.
8 October 2010
The Reserve Bank and NZX run New Zealand’s two principal
The Reserve Bank today announced two developments
securities settlement systems: NZClear and New Zealand
regarding non-bank deposit takers (NBDTs).
Clearing Limited, respectively.
1. Consultation paper on a second NBDT Bill
In December 2009, the Capital Markets Development
The Bank today released a consultation paper seeking
Taskforce recommended that the Reserve Bank and NZX
comment on policy proposals for a second Bill to
Limited work together to ensure an efficient clearing and
complete the legislative framework for the Bank’s
settlement infrastructure that supports the development of
regulation of the NBDT sector.
capital markets in New Zealand.
Deputy Governor Grant Spencer said these proposals
Reserve Bank Deputy Governor Grant Spencer said today
would give the Bank a number of powers covering
that, following an extensive review of alternative options, the
licensing, fit and proper person requirements for
Bank and NZX have agreed to maintain separate competing
directors and senior office holders of NBDTs, the ability
systems but with full interoperability between them.
to place restrictions on changes of ownership, as well as
The agreement is formalised in a Memorandum of
distress and failure management.
Understanding (PDF 1.5MB) which sets out joint objectives
Submissions for the consultation paper close on 5
for the Bank and NZX with regard to the clearing and
November.
settlements infrastructure.
Mr Spencer said that, consistent with its broader liquidity
policy, New Zealand Clearing Limited will be eligible for
2. Implementation of liquidity regulations
The Bank also noted that new liquidity requirements for
backup liquidity support from the Reserve Bank in its
standard overnight facility.
NBDTs have been gazetted.
Further, the Bank and NZX agree to establish a joint
The Deposit Takers (Liquidity Requirements) Regulations
2010 were gazetted on 7 October 2010 and will
settlements advisory council to create a unified approach to
dealing with industry issues.
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
53
Mr Spencer said the Bank and NZX consider agreement on
under the ‘Basel III’ initiative, which is expected to be largely
these issues will help to ensure an efficient and competitive
finalised by the end of 2010, with measures then being
securities settlement infrastructure which will in turn support
introduced over a long phase-in period. The Reserve Bank
the development of New Zealand’s capital markets.
expects to adopt the bulk of these reforms, particularly
around the strengthening of bank capital buffers. However,
measures will not be adopted if they are ill-suited to New
Reserve Bank releases 2009-10 Annual Report
12 October 2010
The Reserve Bank’s broad coverage of financial and economic
functions has proved valuable in dealing with both financial
and natural disasters, Reserve Bank Governor Alan Bollard
said today when releasing the Bank’s 2009-2010 Annual
Report.
Zealand conditions.”
Dr Bollard noted the Bank is now implementing its
regulation of non-bank deposit takers, with requirements in
place for credit ratings, capital, connected exposures, and
the composition of boards. “To make this work for New
Zealanders, the trustees, who are the front-line supervisors,
will have to lift their game,” he said.
Dr Bollard said the Bank is one of the few OECD central
banks to retain all its functions in one organisation. “A
special pamphlet in the Annual Report illustrates how hugely
The Bank is also putting in place regulation of the insurance
industry.
useful it has been during the financial crisis and recovery to
Financially, the Annual Report shows the Bank has made a
be carrying out monetary policy, financial stability, foreign
dividend payment to government of $290 million for the
reserves management, bank regulation, payments and
2010 year. “This leaves the Bank with equity of $2,574
settlements, and currency management all under one roof.
million, a strong base for the potential risks inherent in our
“It has also meant that we were able to assess rapidly how
activities and large balance sheet,” Dr Bollard said.
the recent Canterbury earthquake affected the financial
This dividend follows a voluntary dividend payment in April
system and economy, and where we could assist.”
2010 of $45 million, which the Bank determined was surplus
Dr Bollard said the economic recovery was proving slow and
to its capital requirements emerging from the crisis.
fragile, as could be expected when an economic recession
The Annual Report also shows the Bank has maintained
coincided with a financial crisis.
stable underlying income from interest earnings and stable
“Nevertheless, the Bank is now able to manage a return
to normality through the Official Cash Rate (OCR). Most of
the crisis policies have been withdrawn or are time-limited,
including most of the special liquidity facilities for banks and
operating costs. “Nonetheless, we have recorded a loss of
$111 million for the year ended 30 June 2010, as a result
of unrealised losses arising from adverse revaluations on our
assets and liabilities.”
other institutions and the Bank’s increased foreign reserves
Dr Bollard said most of these losses occurred on the Bank’s
position.”
unhedged foreign exchange position, as exchange rate
The Bank is now focusing on the further development of
New Zealand’s prudential oversight regime for banks, non-
and interest rate movements partially reversed the large
unrealised gains of the previous year.
bank deposit takers and insurance companies. “The Bank’s
“While our reserves are still showing a positive return based
new prudential liquidity policy has been at the forefront of
on purchase costs, we foreshadowed in the 2009 Annual
prudential policy responses to the Global Financial Crisis,
Report the likelihood of volatility in accounting profit and
and has already proved its worth during the Greek sovereign
loss.”
debt crisis.
The Bank and the Minister of Finance have entered into a
“At the same time, we are monitoring international
new Funding Agreement for the five years ended 30 June
developments to strengthen bank regulatory requirements
2015. This was ratified by Parliament on 20 July and focuses
54
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
on extending capacity in new regulatory and surveillance
The Reserve Bank also intends to introduce new disclosure
areas, commencing a programme of upgrading bank notes,
requirements to ensure that the impact of covered bond
and establishing a small office in Auckland to offer more
issuance is transparent. It will do this in the context of the
security in the event of a Wellington earthquake.
wider bank disclosure review currently under way.
This follows a year in which the Bank completed development
Submissions for the consultation paper close on 19
work to improve the robustness and efficiency of its payment
November 2010.
and settlement systems, to update inventory systems to
manage currency, and to fundamentally rebuild financial
The consultation paper can be accessed on the Bank’s
website (www.rbnz.govt.nz/finstab/banking/
and economic statistical systems.
“The financial crisis reinforced that accurate knowledge and
robust controls are crucial for a central bank,” Dr Bollard
OCR unchanged at 3.0 percent
concluded.
28 October 2010
The Reserve Bank today left the Official Cash Rate (OCR)
unchanged at 3.0 percent.
RBNZ consultation on covered bonds
15 October 2010
The Reserve Bank today released a consultation paper on the
introduction of a regulatory framework for the development
of covered bond programmes by New Zealand banks.
Although used extensively in Europe for many years, covered
bonds represent a new funding instrument for New Zealand
banks. Covered bonds are debt securities backed by the cash
flows from a specific pool of mortgages or other loans. They
differ from standard bonds in that investors have specific
recourse to the assets that secure (‘cover’) the bonds in the
event of default, as well as retaining a claim on the residual
Reserve Bank Governor Alan Bollard said: “Despite some
data turning out weaker than projected, the medium-term
outlook for the New Zealand economy remains broadly
in line with that assumed at the time of the September
Monetary Policy Statement.
“Downside risks to the outlook for global growth continue,
with high public and private debt inhibiting recovery in many
developed economies. Moreover, it is unclear how further
policy support would impact on the outlook for growth
in our Western trading partners. Offsetting this weakness,
strong growth continues in China, Australia and emerging
Asia.
assets of the issuer.
“Domestically, recent data has turned out weaker than
Deputy Governor Grant Spencer said covered bond
programmes will benefit the New Zealand banking system
through a broadening of international funding sources,
particularly for the issuance of long term debt.
projected. Continued household caution has seen consumer
spending and housing market activity remain muted, and
many firms have become less optimistic about their future
prospects. However, continued high export prices, along
“The covered bond market is already underway for New
with reconstruction and repairs in Canterbury, will support
Zealand banks under informal guidelines and it will probably
activity over the coming year.
develop further without a formal regulatory framework.
However, the Reserve Bank believes that some relatively
minor legislative changes would usefully support the
development of this market,” Mr Spencer said. “The Reserve
Bank is therefore now consulting on possible legislative
changes, as well as proposals for a formal limit on covered
“Overall, continued GDP growth is expected to gradually
absorb current surplus capacity over the next few years.
Headline inflation is expected to move higher following
the recent increase in the rate of GST. The subdued state
of domestic demand suggests this inflation spike will have
limited impact on medium-term inflation expectations.
bond issuance by each bank.”
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
55
“While it is appropriate to keep the OCR on hold today,
temporary liquidity facility introduced during the financial
it remains likely that further removal of monetary policy
crisis.”
support will be required at some stage.”
The regular Tuesday Open Market Operation (OMO) involves
repurchase transactions for maturities of up to three months.
Liquidity guidelines for non-bank deposit
takers
There has recently been very little use of this facility and the
RBNZ retains the ability to offer term maturity dates at its
discretion in its normal OMOs.
29 October 2010
The Reserve Bank has published non-binding quantitative
liquidity guidelines for the non-bank deposit taking sector.
The guidelines complement the Deposit Takers (Liquidity
Requirements) Regulations 2010 gazetted earlier this month.
Under the regulations, appropriate quantitative liquidity
requirements must be included in an NBDT’s trust deed by 1
This change will take effect from 1 December 2010, with
the final regular Tuesday OMO scheduled for 30 November
2010. The RBNZ will be reviewing over coming months the
remaining measures initiated during the crisis , in particular
the range and credit quality of securities that are repo eligible
in RBNZ operations. Further detail will be announced on this
in due course.
December 2010.
Deputy Governor Grant Spencer said the Guidelines are
intended to help the sector develop quantitative liquidity
“These decisions have no implications for the stance of
monetary policy,” Mr Spencer said.
requirements that are appropriate for an NBDT, and therefore
meet their obligations under the regulations.
Financial system better placed to support
“They outline the matters that an NBDT and trustee should
consider in setting quantitative liquidity requirements,” Mr
Spencer said.
economic growth
10 November 2010
New Zealand’s financial system has benefited from recovery
The guidelines and information on prudential liquidity
in the global economy, with banks now better positioned to
requirements can be accessed on the Bank’s website http://
meet future credit demand and support economic growth,
www.rbnz.govt.nz/finstab/nbdt/requirements/4212995.pdf
Reserve Bank Governor Alan Bollard said today.
(PDF 92KB).
On the release of the Bank’s November 2010 Financial
Stability Report, Dr Bollard said that domestic rebalancing
Removal of temporary crisis liquidity facility
9 November 2010
is proceeding but pressures on the New Zealand dollar are
not helping.
The Reserve Bank announced today that it is removing the
“Households and businesses are keeping spending low
last remaining temporary liquidity facility put in place during
as they reduce debt,” Dr Bollard said. “Combined with
the financial crisis.
improved export commodity prices, this is reducing New
Commenting on the adjustment Reserve Bank Deputy
Governor Grant Spencer said:
Zealand’s current account deficit and external indebtedness,
both of which are positive for financial stability. However,
the New Zealand dollar remains relatively high, reflecting
“Financial market conditions continue to stabilise. Use of
easy monetary conditions and weak economic activity in
the RBNZ’s special facilities, specifically for the purpose of
the major developed economies. If sustained, this will make
accessing term funding, has been low with New Zealand
the continued rebalancing of economic activity towards the
banks able to access funding from their normal market
tradables sector difficult to achieve.
sources. As a result, the RBNZ is removing the regular
Tuesday Open Market Operation which is the last remaining
56
“Emerging Asia remains the main engine of global growth
and this has been positive for New Zealand. Financial markets
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
have become more stable since the European sovereign
He added that the Reserve Bank is generally supportive of
debt crisis earlier in the year. But the widespread withdrawal
the ‘Basel III’ initiative on new international standards for
of fiscal stimulus and debt reduction by consumers and
bank capital and liquidity requirements. “However, we will
businesses continue to pose risks to the global recovery. In
fully assess the potential impacts of these standards before
the US new quantitative measures have been announced
making any changes in New Zealand.”
recently. These appear to be supporting risk asset markets,
but they are also putting pressure on capital inflows and
exchange rates in third country economies, which is
Bank disclosure review outcome: better
problematic for international rebalancing.”
information, less compliance cost
Deputy Governor Grant Spencer said that the New Zealand
banks remain in good shape. They have substantially
increased the stability of their funding base over the past
19 November 2010
The Reserve Bank has finalised the main policy decisions in
its review of disclosure requirements for registered banks.
year, consistent with the Reserve Bank’s new prudential
The Bank issued a consultation paper on registered bank
liquidity policy introduced in April. This has reduced a major
disclosure in August this year and has now followed this up
source of vulnerability highlighted during the financial crisis.
with a policy outcome statement.
Spencer added that the Reserve Bank is now removing its
last remaining crisis liquidity facility.
Deputy Governor Grant Spencer said the changes in
disclosure requirements will significantly reduce banks’
“On the asset side, the level of banks’ non-performing
compliance costs, while at the same time creating more
loans now appears to be stabilising after rising steadily from
manageable disclosure documents that are better aligned
mid-2007. We expect to start seeing an improvement as
with the needs of investors and analysts.
the economic recovery continues into 2011. Risks to this
outcome would arise if the current softness in house prices
were to become accentuated or if agricultural export prices
“Some elements of the regime will be dropped completely,
while other parts, which can be costly to produce, will be
streamlined and simplified,” Mr Spencer said.
were to drop off their current high levels.
“The result will be a regime that produces better, more
In the non-bank sector, we have seen more failures of finance
companies with high exposure to the property development
accessible information for users at lower cost to the
banks.”
sector, most notably South Canterbury Finance. “The
remaining firms in this sector have less exposure to property
and therefore provide a foundation for recovery and industry
consolidation. The non-banks are also now coming into
compliance with the requirements of the new Reserve Bank
regulatory regime, most of which comes into force next
Mr Spencer added that the Reserve Bank appreciated the
level of engagement received from the banks and from
interested users. He said the consensus around the options
presented was encouraging and the Reserve Bank would
now put the preferred option into effect.
month.”
The main changes to the existing regime include:
Mr Spencer said an important new regulatory development
• Dropping the quarterly Key Information Summary and
has been the passage of the Insurance (Prudential
Supervision) Act. The Reserve Bank is now responsible
for prudentially regulating and supervising New Zealand
Supplemental Disclosure Statement.
• Introducing a single quarterly disclosure document
aimed at more financially savvy readers.
insurers. This means all insurance providers, including life,
health and general insurers, will have to meet prudential
standards and be licensed by the Reserve Bank.”
• Cutting by three or four times the size of the half-year
disclosure document, by basing it on interim rather than
full-year accounting standards.
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
57
• Further rationalisation of information across all time
turned out a little stronger than was projected. Consistent
with this, export commodity prices, which were already
periods.
While these main features will go ahead as proposed, the
Reserve Bank has also taken into account concerns raised
very high, continue to increase. While this is encouraging,
downside risks to global growth and export prices persist.
during the consultation process. For instance, the Reserve
“Repairs to earthquake damage in Canterbury are expected
Bank has accepted that the extra compliance cost for banks in
to add to GDP growth over the projection period. The
producing an interest-rate re-pricing schedule every quarter
earthquake appears to have caused about $5 billion of
rather than every six months, outweighs the advantages of
damage to infrastructure, and residential and commercial
more frequent updates for users.
property.
This is the first major overhaul of the disclosure regime
“While the near-term outlook for GDP growth has softened,
since it was set up in 1996 and will better align disclosure
beyond this, higher export volumes and earthquake repairs
information with its original purpose of enhancing market
are expected to push GDP growth above that projected
discipline in the banking sector.
in the September Statement. As growth recovers, current
Subject to the Orders in Council process, required to bring
these changes into effect, the first disclosure statements
under the new regime will be for reporting periods ended
spare capacity will gradually be used up, causing underlying
inflation to pick up. More immediately, the recent increase
in the rate of GST will cause headline CPI inflation to spike
higher temporarily, although there is little evidence of this
31 March 2011.
spike affecting price and wage setting behaviour.
The policy outcome document (PDF 168KB) and the earlier
consultation document (497KB) can be downloaded from
“While interest rates are likely to increase modestly over
the next two years, for now it seems prudent to keep the
the Reserve Bank’s website.
OCR low until the recovery becomes more robust and
underlying inflationary pressures show more obvious signs
OCR unchanged at 3.0 percent
of increasing.
9 December 2010
“The New Zealand dollar has appreciated significantly
The Reserve Bank today left the Official Cash Rate (OCR)
since the September Statement. Sustained strength in the
unchanged at 3.0 percent.
currency is inhibiting the rebalancing of economic activity
Reserve Bank Governor Alan Bollard said: “Interest rates are
towards the tradable sector. Accelerated elimination of New
now projected to rise to a more limited extent over the next
Zealand’s fiscal deficit could help improve national savings,
two years than signalled in the September Statement.
thereby easing current pressure on interest rates and the New
“The pace of economic growth appears to have moderated.
Corporate investment intentions are now below average.
Zealand dollar, and reducing New Zealand’s dependence on
international borrowing.”
Household spending also remains weak, with household
credit still flat and housing market activity slowing further.
House prices may decline a little further in the near term.
This continued household and business caution suggests
current low interest rates are having a less stimulatory effect
than in the past.
“On the positive side, activity in New Zealand’s trading
partners continues to expand. Growth in the Asia-Pacific
region remains strong, and growth in the US and UK has
58
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
PUBLICATIONS
Regular publications
Annual Report
Financial Stability Report
Published in October each year.
Published six-monthly. A statement from the Reserve Bank on
the stability of the financial system.
Monetary Policy Statement
Published quarterly. A statement from the Reserve Bank on the
conduct of monetary policy.
Reserve Bank of New Zealand Statement of Intent, 2010-2013
Recent Reserve Bank Discussion Papers
2010
DP2010/01
DP2010/02
DP2010/03
DP2010/04 DP2010/05
DP2010/06
DP2010/07
DP2010/08
DP2010/09
DP2010/10
Evaluating household expenditures and their relationship with house prices at the microeconomic level
Mark Smith
All together now: do international factors explain relative price co-
movements?
Özer Karagedikli, Haroon Mumtaz and Misa Tanaka
Multi-period fixed-rate loans, housing and monetary policy in small open economies
Jaromír Beneš and Kirdan Lees
Internationalised production in a small open economy
Aurélien Eyquem and Güneş Kamber
Using estimated models to assess nominal and real rigidities in the United Kingdom
Güneş Kamber and Stephen Millard
Sharing a risky cake
David Baqaee and Richard Watt
Exporting and performance: market entry, expansion and destination characteristics
Richard Fabling and Lynda Sanderson
Intertemporal choice: a Nash bargaining approach
David Baqaee
Debt dynamics and excess sensitivity of consumption to transitory wealth Changes
Emmanuel De Veirman and Ashley Dunstan
Does the Kiwi fly when the Kangaroo jumps? The effect of Australian macroeconomic news on the New Zealand dollar
Andrew Coleman and Özer Karagedikli
A full list of Discussion Papers is available from Administration, Economics Department.
Selected other publications
Testing stabilisation policy limits in a small open economy: proceedings from a macroeconomic policy forum
Finance and Expenditure Select Committee inquiry into the future monetary policy framework: submission by the
Reserve Bank of New Zealand
Pamphlets
Explaining Currency
Explaining Monetary Policy
The Reserve Bank and New Zealand’s Economic History
This is the Reserve Bank
Your Bank’s Disclosure Statement – what’s in it for you?
Snakes and Ladders – a guide to risk for savers and investors, by Mary Holm
For further information, go to www.rbnz.govt.nz, or contact:
Knowledge Centre
Knowledge Services Group
Reserve Bank of New Zealand
2 The Terrace, P O Box 2498
WELLINGTON
Phone (04) 472–2029
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010
59
Articles in recent issues of the Reserve Bank of New Zealand Bulletin
Vol. 72, No. 4, December 2009
The Reserve Bank’s new liquidity policy for banks
Assessing recent external forecasts
Banking crises in New Zealand – an historical perspective
The evolution of New Zealand’s trade flows
Vol. 73, No. 1, March 2010
The crisis and the Reserve Bank’s stabilisation rate
Twenty years of inflation targeting
Inflation targeting, the financial crisis and macroeconomics: an interview with Mark Gertler
How may the new architecture of financial regulations develop?
Lessons from previous US recessions and recoveries
The crisis and monetary policy: what we learned and where we are going
Recent trends and developments in currency
Vol. 73, No. 2, June 2010
The Reserve Bank and macro-financial stability
Financial sector amplification and credit cycles in New Zealand
World trade interdependencies: a New Zealand perspective
The Reserve Bank’s new approach to holding and managing its foreign reserves
Vol. 73, No. 3, September 2010
Connecting the dots: a yield curve perspective on New Zealand’s interest rates
The New Zealand dollar through the global financial crisis
Anti-money laundering and countering the financing of terrorism - the Reserve Bank’s responsibilities and approach
The currency denomination of New Zealand’s unhedged foreign reserves
60
Reserve Bank of New Zealand: Bulletin, Vol. 73, No. 4, December 2010